Inclusive Growth: The Asian Experience By Hafiz A. Pasha

Transcription

1 Inclusive Growth: The Asian Experience By Hafiz A. Pasha Asia-Pacific has been the fastest growing region in the world over the last few decades, and has been at the forefront of the process of globalization. The basic question is whether this growth has been inclusive in character and has conferred benefits to all sections of society, especially to those at the lower end of the income scale. In particular, what is the record of the region with regard to poverty reduction? The objective of this paper is to highlight the relationship between growth, inequality and poverty reduction in the Asian context over the last 25 years. This will enable a judgment as to whether growth has been inclusive or not and to derive some insights from the Asian experience as to what are the key elements of inclusive growth. Section II of the paper quantifies the rates of economic growth in different decades in various parts of the region and highlights the sources of this growth. Section III identifies the concomitant trends in inequality, measured in various ways, and describes what has been happening to disparities along various social and economic groups within individual countries. Section IV then presents the results in terms of the extent of poverty reduction. Section V highlights what have been the important drivers of inequality and poverty reduction in the regional setting. In Section VI the same methodological approach is applied to analyzing trends in Pakistan and assessing the inclusiveness of growth in the country. Section VII proceeds to derive some lessons from the Asian experience on how inclusive growth can be achieved. Finally, in Section VIII the key areas of public policy for achieving inclusive growth are described with special reference to the role of sub-national governments. II Rapid Growth in Asia-Pacific The growth rates in Table 1 below demonstrate that Asia-Pacific has been the most economically dynamic region of the world. East Asia and Pacific, in particular, has experienced very rapid growth of over 7.5% per annum since the early 70s. Initially, the trajectory of high growth was established by countries like Malaysia, Thailand, Singapore, Republic of Korea, Hong Kong, and Taiwan (China), now referred to as the East Asian Tigers who opened up their economies early and succeeded in achieving export-led growth initially in labor-intensive manufactures. As a consequence, within one generation, countries like the Republic of Korea, Singapore and Hong Kong (China) have joined the ranks of developed countries; and Malaysia is on the verge of graduating to this status. The author is UN Assistant Secretary General and UNDP Regional Director of the Regional Bureau for Asia and the Pacific. Views expressed here are solely those of the author. 1

2 Table 1: GDP Growth Rates in Asia-Pacific (%) 1980s 1990s East Asia and the Pacific of which: China South Asia Of which: India Other Regions (LACs, SSA, etc) Source: World Development Indicators The big growth spurt that occurred in the 80s was in China, with the initial impetus coming from a process of decollectivisation of farming which provided a big boost to agricultural production 1 and led to a virtuous cycle of rural development with a strong two way linkage between agricultural growth and off-farm employment in village enterprises. Thereafter, China has sustained very rapid rates of growth, averaging almost 10 percent, on the back of high levels of domestic and foreign direct investment in production for export markets. Today, China has emerged as the factory of the world with a large and growing share of world trade in manufactures 2. South Asia has demonstrated more moderate rates of growth up till the 80s when it essentially pursued an import substitution strategy of development. Trade liberalization started in the early 90s, when import tariffs were scaled down gradually 3. Initially, the adjustment process and the displacement effects of liberalization retarded somewhat the growth during the 90s and the manufacturing sector in particular, witnessed a period of relative stagnation. The notable exception was the emergence of service exports from India of software and information technology. Earlier public investments in higher education and relatively low wages gave India the initial advantage. Today, India is increasingly performing back office functions through outsourcing of operations by developed countries 4. In recent years, the euphoria about Asian economic performance has been enhanced even further by the high growth rates achieved simultaneously by the two largest economies (in terms of population) of the region, China and India. India s growth rate has crossed 9% while that of China continues at almost 10%. Given that historically these two countries also had the largest numbers of the poor, the critical question is how the high rates of economic growth have impacted on the incidence of poverty in those two countries. Since 2003, the locus of growth is beginning to shift in the region. Virtually all countries of South Asia (including Pakistan), besides India, have also seen a significant upsurge in their growth rates by anywhere between ½ to 1 ½ percentage points. (See Box 1) The manufacturing sector, in particular, in these countries is beginning to take off on the back 1 Following the decollectivization of farming, the agricultural sector of China grew by over 8% per annum in the first half of the 80s. 2 The export market share of China is estimated at 6% in China s exports have exceeded those of Japan and have been growing at over 16% per annum since The process of trade liberalization started earlier in East Asia. By 1990, average tariffs had fallen to 20 %. By 2000, they were down further to 8%. South Asia had relatively high tariffs in 1990, at an average of about 47%. They have since been brought down to 18% by Indian service exports, especially in IT, have registered rapid growth since 1990 of almost 15% per annum, aggregating to $33 billion by IT exports have made a major contribution to India s balance of payments and growth. The employment generation, however, is limited at about 3 million. 2

3 of rapid growth in exports. Countries like Bangladesh and Pakistan also have large pockets of poverty and prospects have improved in these countries of achieving a faster breakthrough in reducing the incidence of poverty. Simultaneously, most of the middle to high income countries of South East Asia, like Malaysia, Thailand, Indonesia and Philippines are experiencing a slow down. This is not only a long-term consequence of the financial crisis of the late 90s but is also probably a reflection of their loss of competitive edge in international markets at the bottom end in labor-intensive manufactures (like textiles and clothing) to South Asian countries and China; and at the medium to high-tech end, increasingly to China. Fortunately, most of these countries (with the exception of Philippines) have low levels of poverty. Therefore, the pattern of growth in the Asian region is now distributing itself in such a way that augers well for the overall rate of poverty reduction in the region. But this depends on whether; in particular, the higher rate of growth that South Asia is beginning to achieve has the characteristics of inclusive growth and is not accompanied by rising levels of inequality. This takes us to the next section on trends in inequality within countries of Asia-Pacific. Box 1: RECENT GROWTH SPURT IN SOUTH ASIA There has been a visible increase in the growth rate of GDP of South Asian countries in recent years. This growth has been fuelled by a better export performance, rise in agricultural output and buoyancy in both investment and domestic consumption demand. For example, India s manufacturing and services sectors have achieved doubledigit growth rates. Growth Rates Asian Countries GDP (percentages %) GDP Change South Asia Bangladesh India Pakistan Sri Lanka East Asia China Indonesia Malaysia Philippines Thailand Source: ADB 2007 Simultaneously, there has been a drop in the growth rate of middle to high income economies of East Asia, with the exception of China. III. TRENDS IN INEQUALITY IN ASIA-PACIFIC As notable as the phenomenon of rapid growth is the simultaneous increase in inequality in most countries of the region. The Gini coefficient is one of the standard measures of inequality. Estimates of this coefficient for countries on which data is available over time is given in Chart I below. Inequality has increased in virtually all countries including Bangladesh, China, India, Lao PDR, Nepal, Pakistan, Sri Lanka and Vietnam. The exceptions are Philippines, where it has remained unchanged at a fairly high level, and Thailand where it has declined somewhat, although still at a relatively high level. 3

4 Chart 1 60 TRENDS IN GINI INDEX IN ASIAN COUNTRIES 40 Gini index 20 0 Ban China India Indo Laos Malay Nepal Pak Philip SRL Thai Viet Source: UNDP (2006) Recent There have been concerns about rising inequality in Pakistan. But it is important to recognize that this is not a unique to the country but it is a regionwide phenomenon. In fact, as the recent ADB (2007) study has shown Pakistan not only has had a relatively low level of inequality but has also experienced a very small increase in inequality from 1990 to The magnitude of the Gini coefficient has risen much more rapidly in countries like China, Bangladesh and India 5. Another, perhaps more direct and revealing indicator of the extent of inclusive growth, is the rate of increase in expenditure or income of different population percentiles. Chart II gives the rates of growth in real consumption expenditure of the bottom 20% and the top 20% of the population respectively. Rising inequality is demonstrated by the fact that in most countries the top 20% have experienced bigger increases than their counterparts in the bottom 20%. For example, the ratio of the increase for the two groups in China and India was over 2:1 between 1990 and %Change in 1993 PPP$ Chart II Growth rate of Consumption Expenditure Per Capita, s (% Change annually in 1993 PPP$) Bangladesh Source: ADB (2007) China India Indonesia Malaysia Nepal Pakistan Philippines Sri Lanka Thailand Vietnam Bottom 20% Top 20% 5 The Gini coefficient has increased annually during the period, 1990 to 2004, at the rate of 1.35% in China,.88% in India, and 1.34% in Bangladesh, as compared to only.24% in Pakistan. 4

5 Another way of looking at inequality is to measure the ratio of per capita expenditure by, say, the top 20% of the population to that by the bottom 20%, rather than the relative growth rate. A large gap can be a source of discontent, especially if there is display of affluence by the rich in an otherwise poor country. Chart II gives this ratio for different countries of Asia-Pacific. It has already crossed eleven in China and is also relatively high in other countries like Philippines and Nepal. ADB (2007) has argued that the high and rising level of inequality in Nepal is one of the root causes of conflict in the country. Pakistan has the lowest ratio at just under 4 ½. As demonstrated by the chart, the ratio of consumption expenditure between the top 20% and the bottom 20% tends to rise very rapidly with an increase in the Gini coefficient. The elasticity is estimated at about 3, that is, for every one percent increase in the Gini coefficient, the ratio increases by about 3%. Chart III Ratio of Per capita Expenditure by Top 20% to Bottom 20% 12 Ratio of top 20%to Bottom20% Source: ADB (2007) Gini Value The household income and expenditure surveys are generally incapable of capturing the share of income accruing to the upper tail of the income distribution, say the top 1% or so. In fact, total income derived from such surveys is only about 40 to 50% of the national income in countries like India and Pakistan. Therefore, a large part of the income remains unreported. An indication of the trends in income/wealth of the super rich can only be had from other sources of information. One such source is the Forbes magazine, which reports that India has as many as 35 dollar billionaires as compared to 24 in Japan and 20 in mainland China. It is indeed surprising that there are so many super rich individuals (with a combined net worth of almost $ 200 billion) in a relatively poor country like India. Clearly, the distribution of wealth and income in India is more skewed than revealed by estimates from household income and expenditure surveys. In the Pakistani context, the quantum jump in corporate profitability by almost 300% between 2002 and 2005, accompanied by over eleven times increase in the share price index must have led to a further concentration of wealth in the country. The inescapable conclusion is that Asia-Pacific, by and large, has not achieved inclusive growth of the type which leads to a convergence along the income/expenditure scale. The primary reason for this is that policy makers have in most countries singlemindedly pursued the goal of high growth and have largely relied on trickle-down effects of 5

6 growth on improving the living standards of people at the bottom of the income ladder. Fortunately, while this trickle down effect has been limited it has not been non-existent. As a consequence of relatively rapid growth, some benefits have reached the poorer segments of society. It is worth noting that there has been an increase, albeit relatively small, in the expenditure level of the bottom 20% of the population in most countries. The only exception is Pakistan and this explains why poverty has been rising in the country for most of the 90s. The joint occurrence of high economic growth along with rising inequality in the Asian context has led to the view either that high inequality is good for growth of that rising inequality is the inevitable consequence of growth. (See Box 2) Box 2: GROWTH AND INEQUALITY There appears to be some correlation between rate of growth of per capita expenditure and the rate of increase in inequality during the period, 1990 to There is a tendency, especially in East Asia, for inequality to rise faster in countries which are experiencing more rapid growth, as show below: East Asia and the Pacific Change in Gini Coefficient (% points) Relatively fast growing countries (China, Vietnam, Lao PDR,) 4 ½ Relatively slow growing countries (Philippines, Indonesia, -1 ½ Malaysia, Thailand) South Asia Relatively fast growing countries (India, Sri Lanka) 5 Relatively slow growing countries Bangladesh, Pakistan) 3 ½ It is significant that inequality declined in East Asian countries which were hit more severely by the financial crises of the late 1990s. It appears that the poor who operate more on subsistence non-market economy were more insulated from the crises. The latter is essentially a reflection of the observation by Simon Kuznets (1955) that initially in the earlier stages of development as the modern sector expands inequality has a strong tendency to rise and that it is only in the mature stages of development when the more productive sectors have expanded sufficiently that inequality will begin to fall. It is interesting, however, that the experience during the 70s and more recently of some East Asian countries like the Republic of Korea and Taiwan (China) contradicts this hypothesis. Over the last three decades or so, the level of inequality remained, more of less, unchanged in these countries while they experienced rapid development. The view that inequality is good for growth also has some theoretical foundations. Nicholas Kaldor (1956) had argued for example, that marginal savings rates of the rich are higher and if investment rates are to be enhanced for achieving faster development then it becomes essential to divert resources towards the higher income groups. During the 60s, this was part of the dominant paradigm of development and was the intellectual underpinning of the second Five Year Plan, for example, of Pakistan. However, the resulting regional inequalities may have been one of the reasons for the break-up of the country in The Asian view now is that there is need to distinguish between good and bad inequality from the viewpoint of growth. Good inequality is inequality which raises returns to education and investments in human capital, to risk taking and entrepreneurship, and to prudent savings behavior. Inequality is bad if it is the consequence of imperfect capital markets or lack of access to opportunities due to circumstances and overt or covert forms of discrimination or the result of the capture of rents by powerful vested interests. 6

7 But it is clear the inequality has to remain within tolerable limits if a breakdown of the social order is to be averted as manifest in high levels of crime and violence, and ultimately to an environment which is not conducive to further growth. At the minimum, inclusive growth must involve improvement in living standards simultaneously of all social and economic groups, albeit at differential rates. In this sense, Asia as a region passes the weak test for inclusive growth. The evidence is that countries in which inequality has increased, regional disparities have also widened at the sub-national level. This is frequently a reflection of the difference in initial conditions at the start of the growth process in terms of levels of human development and availability of infrastructure. For example, data is available on State Domestic Products in India, which show that the six states with the highest per capita incomes have grown at a rate which is significantly higher than that of the six poorest states/union territories 6. In China, levels of economic activity and human development have diverged between the provinces as a consequence of public policy which concentrated the special economic zones, especially for attracting FDI, in the coastal regions in order to achieve efficiency gains through agglomeration economies. Today, Shanghai province has a high human development index (as developed by UNDP) of 0.92 while the provinces in the Western regions have an index value ranging from 0.55 to In Pakistan a study by Social Policy and Development Centre (2004) reveals that the two more developed provinces of Sindh and Punjab have shown a combined growth rate of 5.2% between and , while the two more backward provinces, NWFP and Balochistan, have managed jointly a growth rate of 4.9%, implying only a minor divergence in long-term growth rates. Another important source of rising inequality is the growing gap between rural and urban incomes. The concentration of the modem and more dynamic sector in cities, especially the megacities, has led to faster increases in per capita incomes, even if this is partly mitigated by rural-urban migration. In China the ratio of urban to rural income was 2.2 in 1990 which has risen to 3.2 in According to ADB (2007), the growing urban-rural gap has contributed more to the overall level of inequality in China than disparities among households within urban or rural areas. In India also, estimates are that the gap is increasing and rural incomes are now only about half the level of urban incomes on a per capita basis. A somewhat contrasting trend is observed for Pakistan where the gap has remained, more or less, unchanged between and IV. PROGRESS IN POVERTY REDUCTION Table 2 presents the number of people living below the international poverty line of $1 per capita per day, measured in PPP terms, in Asia-Pacific. The total number of the poor has declined from1270 million in 1980 to 632 million in million people have been taken out of poverty in a period of less than 25 years, 315 million in the 80s and 323 million after This is a truly impressive achievement, probably unprecedented in human history. 6 The six states /union territories of India with the highest per capita product are Goa, Chandigarh, Delhi, Pondicherry, Maharashtra and Punjab, while the six poorest states/union territories are Bihar, Uttar Pradesh, Orissa, Assam, Jharkhand and Chattisgarh. The former have grown at 5.2% and the latter at 3.6% between and

8 Table 2: The Number of Poor in Asia-Pacific (millions) East Asia and the Pacific of which: China Rest of east Asia South Asia Of which: India Rest of South Asia Asia and the Pacific Incidence of Poverty in Asia-Pacific (% below 1$-PPP-a-day) East Asia and the Pacific of which: China Rest of east Asia South Asia Of which: India Rest of South Asia Asia and the Pacific Source: World Bank, Global Monitoring Report 2007 But the record in terms of the rate of poverty reduction is mixed. East Asia has been able to bring down poverty dramatically while high levels of poverty persist in South Asia. Much of the poverty reduction has occurred in one country, China, which has brought down the number of its poor by as much as 508 million, equivalent to 80% of the overall poverty reduction by the region. In terms of the incidence of poverty, Asia-Pacific is well on track as a region to achieving the Millennium Development Goal (MDG) of halving poverty by 2015 (in relation to the base level in 1990). In 1990 roughly one in three persons living in the region was poor, which has fallen to below one in five by now. East Asia has already achieved the target, but South Asia remains somewhat off-track and will have to perform better in the remaining years to 2015 if the target is to be achieved. However, if, as mentioned earlier, the recent upsurge of growth is sustained then prospects for halving poverty are distinctly better. We come now to a summary measure of the degree of inclusive or pro-poor growth. This is the poverty-growth elasticity, which indicates the percentage change in the incidence of poverty with a one percentage point change in the economic growth rate per capita. A faster decline in poverty for a given growth rate implies that the growth process has been more inclusive in reaching out to the poor. The observed magnitudes of the elasticity, which are given in Table 3 can be compared with -2, which is estimated to be approximately the magnitude by Ravallion (2001) if inequality remains unchanged. Table 3: Poverty to Growth Elasticity in Asia-Pacific East Asia and the Pacific of which: China Rest of east Asia South Asia Of which: India Rest of South Asia Source: Author's estimates 8

9 As highlighted earlier, the degree of inclusiveness of Asian growth is relatively low, with the exception of the rest of East Asia (excluding China). This includes countries like Malaysia and Thailand which have been able to achieve high rates of growth with declining inequality, while inequality remained unchanged in the Philippines. Malaysia, in particular, has followed a strong affirmative program to improve conditions for the dominant though depressed ethnic group (Bhumiputras). China s poverty-to-growth elasticity is of an intermediate order and declined to a relatively low level in the 90s. As highlighted above, it has still been able to reduce poverty substantially because of its phenomenal growth. However, China s strategy of combining a very high growth rate with rapidly increasing inequality for achieving poverty reduction is clearly not a replicable strategy. It would be difficult for any economy to sustain China-type of double-digit growth rates over long periods of time. The big surprise in terms of the low magnitude of the poverty-to-growth elasticity is India, especially after In a functioning democracy with a modicum of welfare orientation, the voice of the poor ought to have been stronger in ensuring that the fruits of growth are more evenly shared. What explains India s inability to reduce poverty more rapidly, especially in the presence of social safety nets like a public food distribution system and an affirmative action program in favor of scheduled castes and tribes? We attempt to answer this question in the next section. Overall, it is estimated that if inequality had not worsened in the countries of the region, then another 168 million people or an additional 50% could have been taken out of poverty between 1990 and This is, of course, based on the assumption that actions to prevent inequality from rising would not have had any deleterious effects on the rate of economic growth. V. DRIVERS OF INEQUALITY AND POVERTY What explains the, more or less, pervasive trend of rising inequality in Asia-Pacific? Answers to this question lie in the structural changes in the economies and the resulting pattern of growth, in associated changes in labor-markets and a relative lack of emphasis on investments in human development to enhance the capabilities of people at large. There is also a growing recognition now that the process of liberalization and globalization pursued vigorously by Asia-Pacific over the last two decades may have also fundamentally contributed to rising inequality. Neglect of Agriculture and Rural Development: At the time when most countries embarked on the path of growth, they were essentially agricultural societies with bulk of the population residing in rural areas. There was generally a high degree of optimism on the part of planners that an Arthur Lewis type of structural transformation could be achieved by focusing on shifting labor out of low productivity agriculture with disguised unemployment towards the modern industrial sector characterized by higher levels of productivity. This was coupled simultaneously with a degree of export pessimism with regard to agriculture. A long-term deterioration in the terms of trade of primary commodities along with large subsidies offered on competing exports by developed countries implied limited prospects for growth in agricultural exports 9

10 by developing countries. As opposed to this, the prospects for fast growth in exports of laborintensive manufactures were considered much better. The initial results in the 1970s confirmed, by and large, these views. The rapid growth achieved by many East Asian counties in pursuing this path of rapid export-oriented industrialization has motivated many others, especially in South Asia, to abandon an importsubstituting strategy more recently and embark on the road to export-led growth. The inevitable consequence has been a neglect of agriculture and a visible decline in sectoral growth in the 90s throughout the region. The growth rate of agriculture in South Asia which was about 4% in the 80s, declined to 3% in the 90s and has fallen to 2 ½ % in recent years. (as shown in Table 4) Simultaneously, there has been an even sharper decline n the growth of food production to about 1½ %. East Asian agriculture has been somewhat more buoyant with an average growth rate of about 3½ % during the last 15 years after registering a high growth rate of almost 5% in the 80s. However, in the face of rapidly rising domestic demand, East Asia has become a big net agricultural importer in recent years. Table 4: Sectoral Growth Rates in Asia-Pacific (%) East Asia & the Pacific 1980s Agriculture (Food Production) Industry Services GDP South Asia Agriculture (Food Production) Industry Services GDP Source: World Development Indicators The neglect of agriculture has been visibly manifest in the declining share of public sector investment allocations to the sector (see Box 3). This has occurred at a time when as a result of growing population pressures serious constraints are emerging with regard to the availability of water and land, and over-exploitation of natural resources has raised serious issues of sustainability of existing levels of production. BOX 3: Declining Public Allocations for Agriculture and Rural Development The share of agriculture, rural development and irrigation in actual public sector allocations has been declining steadily in India and Pakistan in the various plan periods. In India, the combined allocation for the three sectors peaked in the late 70s at over 27%. It fell to 21% in the Eight plan period ( ), to 20% in the Ninth plan period ( ) and to below 19% in the Tenth Plan period ( ). The decline in share of allocations has been more pronounced in Pakistan. The share peaked in the Second plan ( ) and Third Plan ( ) periods at over 45%. This was the time of the Green Revolution in Pakistan. The share fell to 16% in the Sixth Plan period ( ). During the last six years it has averaged about 10%. 10

11 Perhaps one of the most important reasons why poverty has not declined more rapidly in India in the 90s is the relative stagnation of Indian agriculture, following a period of some dynamism in the 80s. India has had to import large quantities of wheat, a significant reversal for a country which achieved surplus food grain production and carried large stocks in the 1980s. The large number of suicides by Indian farmers is a tragic reminder of the need to focus on the problems of the 70% or more of the poor who live in the Asian countryside. It is clear that if Asia-Pacific is to experience inclusive growth than the priority to agriculture and rural development will have to be restored once again. It is encouraging, for example, that the Union government of India has begun to make substantially larger allocations for rural development which along with better monsoons have helped Indian agriculture to revive somewhat in the last three years 7. A rural employment guarantee scheme has also been launched. Failure in Employment Generation The second reason why growth has not been so inclusive in Asia-Pacific is the failure to create enough decent and remunerative jobs for the expanding labor force. Region wide unemployment rates have been rising even in the presence of rapid economic growth 8. The expectation that labor could be released from agriculture and rapidly absorbed in industry has largely not been realized during the last 15 years. This failure is most evident in East Asia. As Table 5 shows, the growth rate of employment in East Asia has plummeted from over 4 percent in the 80s to only about 1 percent since There has been a net contraction of the labor force in agriculture, as expected, but despite over double-digit growth rates of industrial output, employment in the sector has expanded very slowly at less than 1% annually in the 90s. South Asia has been able to sustain its employment growth rate, albeit at the low rate of about 1½ %. Table 5: Growth Rate of Employment in Asia-Pacific East Asia & the Pacific 1980s Agriculture Industry Services Total South Asia Agriculture Industry Services Total Source: World Development Indicators The consequence is that much of the incremental labor absorption is taking place in the informal services sector in relatively low productivity occupations like trade and personal 7 The rate of growth of Indian agriculture has risen somewhat during the period, to , to over 3% from about 2.5% during the decade of the 90s. Latest estimates for are that it has crossed 4%. 8 The unemployment rate in North East Asia (including China) in was just above 2%. It has almost doubled to 4% by In South East Asia it has risen from 4.5% to over 6% and in South Asia from 4% to just under 5%. 11

12 services. This has led to overcrowding and poor living conditions in urban slums, especially in the megacities of Asia-Pacific. The pavement economy of Bangkok, for example, is a visual manifestation of this phenomenon. What Asia is doing is shifting labor from disguised unemployment in the rural areas in agriculture to the urban informal sector. It is not surprising, therefore, that half the poor in Asia are actually the working poor. Simultaneously with the low overall rate of labor absorption, there are distinct changes in the labor market. The skill premium is rising, especially in East Asia, as this subregion moves towards the adoption of more capital-intensive technologies and high-tech products. This divergence in wages between skilled and unskilled workers is another factor contributing to rising inequality. Underinvestment in Human Development One of the fundamental pre-requisites for successful inclusive growth is the need to invest in enhancing the capabilities of the people so that they can both create and also take full advantage of the opportunities arising in the process of development. It is significant that at the time that East Asia embarked on rapid growth in the 70s, it already had relatively high levels of human development levels which South Asian countries have attained only recently 9. Despite these low levels of human development, South Asia has failed to enhance public allocations for education and health during the 90s. In Pakistan, for example, in a period of macroeconomic instability and relatively low growth in the 90s, allocations for education fell below 2% of the GDP and to below 1% of the GDP on health, even though a promising start had been made in the early 90s with the Social Action Program. The economic recovery since 2002 has not led to any major improvement in public allocations to social services. Instead, the share of higher education has been increased in the presence of continuing low levels of enrollment at the primary and secondary level. The change in education priorities may contribute to growth but is likely to exacerbate inequality 10. Altogether, improvements in social indicators have floundered generally not only on the grounds of limited expenditure but also because of low levels of efficiency in the delivery of social services. However the Bangladesh experience shows how even an LDC, with low public allocations but a vibrant non-governmental sector, can make a breakthrough in social indicators within a decade. Today, Bangladesh has been able to equalize school enrollments of girls with boys and achieve universal enrollment, bring down sharply the population growth rate through the spread of family planning, and achieve sharper reduction in infant mortality in relation to other countries of South Asia 11. A UNESCAP-UNDP-ADB report (2005) on the MDGs highlights that the least progress has been made by the region in attainment of the health targets. The region is 9 The HDI for China as far back as 1975 was.53. India s HDI in 1970 was much lower at.42. It approached the 1975 level of China only in The level of education expenditure by federal provincial and local governments combined was 1.8% of the GDP in , which has risen to 2.1% of the GDP in However, expenditure on higher education has grown three times as fast as expenditure at primary and secondary levels. 11 Under five mortality was brought down by Bangladesh from as high as 239/1000 births in 1970 to 69 in The corresponding estimates for India and Pakistan are 87 and 103 respectively in

13 seriously off-track in reduction of infant and maternal mortality and is increasingly vulnerable to diseases like TB, malaria, HIV/AIDS, and avian flu. There is need to recognize that a healthy and educated labor force is essential not only for sustaining high rates of growth but also for ensuring a wider distribution of the benefits of growth. Consequences of Liberalization and Globalization Some of the failures in achieving inclusive growth like the loss of momentum in agriculture and the emergence of relatively jobless growth can be attributed at least partially to the process of liberalization embraced by the region. Of particular significance in this regard is trade liberalization, involving the reduction of tariff and non-tariff barriers. In the immediate aftermath of such liberalization, there has been a significant displacement effect on domestic activities, especially in the manufacturing sector in South Asia. For example, industries of an import-substituting nature which have been adversely affected include leather and footwear, wood products, industrial chemicals, rubber products, plastic products, paper and paper products, glass products, fabricated metal products, and professional and scientific equipment. This, at least, partly explains the decline in growth rate of the manufacturing sector in the 90s. Trade liberalization has also exercised significant effects on the labor market, especially in East Asia. For example, as China prepared for entry in the WTO, a large number (over 46 million) of workers were laid off from public and collective enterprises in an effort to raise the competitiveness internationally of such entities. The flow of FDI, particularly to China, in the form of out-sourcing of parts of the value added chain has actually led to a rise in the capital and skill-intensity of production. It turns out that the investments which have embodied technologies that are labor-intensive by investing country standards are actually more capital-intensive in the recipient country. A classic example of this is the assembly of electronic goods and office equipment and machines in China. Furthermore, the competitive pressures of globalization have compelled enterprises to engage in greater quality control and upgrading which has also implied greater demand for skills. In addition, financial sector liberalization has reduced the flow of credit to labor-intensive small and medium enterprises. Therefore, the process of trade liberalization has not only implied a move towards greater capital-intensity and reduced labor demand, it has also raised the skill premium. In East Asia and Pacific the share of high-tech capital-intensive exports increased from 24% to 41% during the decade of the 90s. Overall, it has contributed to greater inequality while enabling faster growth of manufactured exports from East Asia and of service exports from South Asia. A more recent development it the rising problem of the fallacy of composition in the export market for textiles and clothing. The demise of the quota regime in early 2005 has greatly intensified competition for markets in EU and the US among the large number of Asian producers. The ability of China and India, the two big producers to enjoy significant economies of scale, has meant that unit prices have tended to decline due to the intensified competition. It is estimated that these two countries have captured 80% of increased exports from Asia of textiles and clothing in 2005 and (See Box 4) 13

14 BOX 4: Changing Market Shares in Textiles and Clothing Following the withdrawal of textile quotas in January 2005, Asian exporters have collectively done well in the original quota markets of the EU and USA, achieving a cumulative growth of 44% during these two years as compared to the overall market growth of 14%. However, the performance of individual Asian countries has varied widely, as show below: Textiles and Clothing Exports to EU and US ($ Billion) Country* % Increase China India Bangladesh Vietnam Indonesia Sri Lanka Pakistan Philippines Thailand Source : UNDP (2006); *With exports in excess of $2 Billion in 2004 The changing market shares have major implications for countries like Bangladesh, Pakistan, Cambodia, etc. which rely on textiles and clothing for a large part of industrial value added and employment. Bangladesh exports have managed to survive in the presence of enhanced competition and textiles and clothing exports have grown cumulatively during the last two years by over 30%. But Bangladesh is beginning to experience immiserising growth, whereby growth is being accompanied by falling real wages and deteriorating living conditions of workers. Meanwhile, Pakistan is experiencing difficulties in even sustaining its market-share. VI THE PAKISTAN EXPERIENCE We have highlighted in the previous sections the following trends in Pakistan: (i) Pakistan experienced relatively low rates of growth during the 90s, but growth has picked up appreciably in the last four years. (ii) The inequality level is relatively low in Pakistan and has deteriorated only marginally in the 90s. (iii) Primarily because of low growth, levels of expenditure of the poorest segments have fallen slightly. (iv) There was consequently no major improvement in the poverty situation in the 90s. Analysis of the growth trends by sector of Pakistan reveals that while Pakistan has had relatively low growth of about 4½ % during the 90s, the growth, however, has been very balanced. In particular, the agricultural sector has been buoyant and there has been little divergence between the growth rates of the primary, secondary, and tertiary sectors 12. The relatively high growth rate of agriculture should have helped in alleviating rural poverty. The failure of the manufacturing sector to grow rapidly can be attributed to depressed conditions of domestic demand in a period of macroeconomic stringency and failure of 12 The growth rates of the primary, secondary and tertiary sectors were 4.3%, 4.4% and 4.4% respectively. 14

15 exports to grow rapidly. Economic revival has since been led by the manufacturing sector, fuelled by expansionary monetary and fiscal policies and revival of exports. Here again, the positive aspect of Pakistan s growth story of the 90s is the ability of the economy to sustain relatively high rates of employment growth during a period of relatively low economic growth. The former is estimated at about 2½ percent, significantly higher than for South Asia as whole. Because of relatively rapid agricultural growth, there has been no net labor displacement from this sector and employment in services has shown healthy growth. World Bank (2005) estimates are that from to , Pakistan was able to show some, although modest, decline in the incidence of poverty, from 34% to 32.6%. This is despite the low rate of economic growth, primarily because inequality did not rise. We have the conclusion that while Pakistan may not have experienced much growth in per capita income in the 90s, whatever growth that has occurred has been more inclusive in character than for the South Asia as a whole. This can be attributed to relatively fast rates of growth of agriculture and employment. The resurgence of growth since 2002 has, in fact, been accompanied by a slow down in the rate of agricultural growth from 4% to just over 3.5% up to In between, there have been two years of drought which must have adversely affected the living conditions of rural households and driven many of them into the poverty trap. The buoyancy of the manufacturing sector has, however, exerted a strong pressure in labor demand in the sector. Employment has therefore probably grown faster in recent years 13. There is some disagreement about what has happened to the incidence of poverty after Based on the HIES of , the government estimates that poverty has fallen from 34.5% in to 23.9% in Adopting a somewhat different methodology on the same database, the World Bank (2006) concludes that poverty has declined less to 29.2% in If government estimates are accepted, then the poverty-growth elasticity for the period, to , turns out to be high at This is plausible only if there has been no worsening of inequality in the intervening period. But the evidence points to a significant divergence in the growth rates of real consumption expenditure of different income groups. Chart IV gives the growth incidence curve for Pakistan from to The growth rate of the highest quintile has been more than twice that of the lowest quintile, although all quintiles show significant positive growth. 13 According to the Labor Force Survey of , there has been a large jump in employment of almost 12% in relation to the level recorded in the previous survey of However, this estimate of growth is likely to have an upward bias because the first time in an attempt was made to survey during all four quarters and to capture, in particular, for the seasonality in agricultural activities. 15

16 Chart IV Growth Incidence Curve, Pakistan to Average % Growth in Consumption Expenditure Quintile Source: Federal Bureau of Statistics, HIES One of the reasons for the divergence is the return of high inflation in Pakistan, especially of food prices (see Box 5), which has had a differential impact on the lower income groups. BOX 5: The Scourge of Rising Food Prices During the last three years food prices have been rising rapidly in many Asian countries. This has contributed to more rapid rates of inflation as shown below for three countries- Pakistan, India, and Indonesia. Part of the inflation is due to domestic supply and demand conditions of food items. But international prices have also been rising rapidly. For example the cumulative increase from 2005 to 2007 in the international price of wheat, maize, rice and palm oil is 60%, 71%, a17%, and 92% respectively. Food and Overall Rate (%) 2000 to to 2007 Pakistan Food Prices CPI India Food Prices CPI Indonesia Food Prices CPI Sources: Pakistan Economic Survey; ;Indian Economic Survey and Indonesia Economic Statistics The conclusion is that for Pakistan also a higher rate of economic growth is probably being accompanied by rising inequality. This explains the concerns being expressed about the rising gap between the rich and poor. The visible consumption boom, especially with the explosion in asset values in the stock market and the urban real estate market have fuelled these concerns about the growing concentration of wealth in the country. In view of this evidence, the World Bank estimate about the extent of decline in poverty is probably more reasonable. It is still large enough to indicate a poverty-to-growth 16

17 elasticity of Pakistan between and of about This is higher than that for South Asia, implying that Pakistan continues to experience somewhat more inclusive growth than its neighbors. Will Pakistan be able to achieve the MDG target of halving poverty by 2015 on the basis of current trends? Due primarily to the slow progress in the 90s, the required rate of poverty reduction from 2005 onwards is over 5% per annum. With the present poverty-togrowth elasticity, this will require a growth rate of GDP of about 7%. Therefore, with a growth rate of about 6%, the degree of inclusive growth will have to be even greater if Pakistan is to be able to achieve the poverty reduction target. VII. LESSONS FROM THE ASIAN EXPERIENCE Based on the Asian experience, we are now in a position to highlight what are the key elements of a strategy for achieving more inclusive growth, especially in terms of the effect on people living in poverty. These elements are summarized in the following principles: (i) Growth should take place in sectors in which the poor work : It is clear now that there is need to focus on agricultural growth and rural development. Over 70% of the poor in most Asian countries are engaged in rural economic activities and need support in raising living standards through public investments in rural infrastructure and services. In particular, the focus must be on raising productivity of small farms and on promoting off-farm employment opportunities in rural areas. (ii) Growth should occur in backward and marginalized areas where the poor live: The experience of Asia-Pacific highlights the danger of widening regional disparities during the process of growth. Poverty rates are generally much higher in backward areas, sometimes over twice the national average. Therefore, the development strategy has to focus on uplift of backward areas and removal of the basic obstacles to growth. Initially, the public sector will have to take the lead through investments in physical and social infrastructure to remove these obstacles to growth. The private sector can then be encouraged to invest in such areas through the provision of appropriate fiscal incentives and tax breaks. (iii) Growth should use the factors of production that the poor possess and enhance their capabilities: Labor demand created during the process of growth should be concentrated on creating employment opportunities for unskilled and semi-skilled workers. Sectors characterized by high levels of labor-intensity should be encouraged by preferential allocations of credit and tax treatment. In addition, the ability of the poor to avail the emerging opportunities needs to be enhanced by higher investments in human development, especially on basic education and health services. (iv) Growth must keep prices of goods and services consumed by the poor, like food, relatively low: high rates of growth may fail to achieve significant poverty alleviation if simultaneously the rate of inflation, especially in food prices, also rises. Not only is there a need for supporting domestic food production but also for improving marketing arrangements of such items. Therefore, an inclusive growth strategy has to focus on sectors, areas, factors of production and items of consumption which can play a special role in alleviating poverty. Beyond this, it is also important to recognize that particular groups are more vulnerable to being excluded or marginalized from the process of growth. Special programs 17