Rising Income Inequality in Asia

Transcription

1 Ryan Lam Economist Joanne Yim Chief Economist 14 June 2012 Rising Income Inequality in Asia Why inequality matters Recent empirical studies suggest the trade-off between income equality and economic efficiency is not always inevitable. A high level of income inequality, in fact, constitutes significant impediment to achieving the social and political stability needed for sustained economic growth. Asian countries saw a widening gap between different income classes Income inequality as measured by the Gini coefficient has risen from 0.39 in mid-1990s to 0.46 in late-2000s for Asia. Mainland China, Indonesia, Sri Lanka and Hong Kong have seen sharper increases in Gini coefficients. What drives the change in inequality The results of our analysis highlight that economic restructuring and rapid technical changes are the main reasons for rising income disparity. The role of trade liberalization on determining income distribution, however, appears to be overstated. The path going forward Income discrepancies among countries will likely narrow due to the catch-up of growth in Developing Asia relative to that in mainland China. But within-country income inequality is forecast to rise in most Asian countries, as a result of economic transformation and a shift of job creation linked to technological change. On a positive note, confronting rising inequality is now a major national agenda in many Asian countries. Allowing for in-kind transfers, Asia has a lower Gini coefficient than that of the economies with comparable income levels.

2 Why inequality matters For a long time income inequality has been one of the major themes of socio-political debate. Interests in inequality from an economic perspective, however, have only increased in recent decades. The conventional wisdom among policy makers is that there always exists a trade-off between income equality and economic efficiency. The widening gap between the rich and poor could be regarded as an inevitable price to pay for growth and development. While there are moral and social reasons for concerns about inequality, they seem not to have much to do with economic policy per se. However, after the post-war economic boom petered out, concerns linking income concentration to macroeconomic problems started to receive growing attention among economists. Since then, a substantial body of empirical studies regarding the effect of income inequality on economic growth has been accumulated. Based on more reliable data set and improved statistical methods, recent empirical studies suggest, in contrast to the predictions of the conventional economic theory, that rising equality could have adverse implications for economic growth via the following transmission channels (Exhibit 1): Detrimental for human capital formation. The underprivileged who cannot borrow and miss out on potentially high return of investments are left with little resources for training or education. Higher fertility rate. Poor households tend to have higher fertility rates but provide lower level of education for each child. Inadequate public services. When inequality has taken hold, there is growing risk that government fails to respond to citizens needs and change of market landscape. Unfriendly business environment. The authority might face greater pressure from the poor masses for wealth redistribution. Higher taxes will reduce assets return and hinder capital accumulation. Social unrest. Individuals in a divided society will have incentives to engage in unlawful activities. Exhibit 1: Major studies regarding the effect of income inequality on economic growth Main conclusions Berg and Ostry (2011) A 10% decrease in inequality increases the expected length of a growth spell by 50% Banerjee and Duflo (2003) Growth rate is an inverted U-shape function of net changes in inequality Barro (2000) Inequality hinders growth in poor countries but has positive effects on growth in rich countries Deininger and Squire (1998) There are strong negative effect of land inequality and modest negative effect of income inequality on growth Source: Hang Seng Bank 2

3 The conceptual framework of the interplay between inequality and economic growth is set out in Exhibit 2. The framework illustrates a high level of income inequality, in fact, constitutes significant impediment to achieving the social and political stability needed for sustained economic growth. Exhibit 2: A conceptual framework for the interplay between inequality and economic growth Assets & Opportunities Market Mechanisms Household Formation Governance Institutions Public Redistribution Power Social/Political Institutions Outcomes & Incomes Sources: World Bank, Hang Seng Bank Asian countries saw a widening gap between different income classes Rising income inequality is not a recent development but has been evident for the last few decades. Levels of inequality vary widely around the globe, but the tendency towards greater concentration of income at the upper income class is a general trend. To set the scene, income inequality as measured by the Gini coefficient 1 has risen from 0.39 in mid-1990s to 0.46 in late-2000s for the Asia (Exhibit 3), indicating more unequal distribution of income in the region. The regional inequality can be disaggregated into two parts: (1) the differences in mean countries incomes (between-country inequality) as well as (2) the differences in personal incomes within the same country (within-country inequality). A study by the Asian Development Bank (2011) suggests that between-country inequality accounts for an increasing share of overall income inequality in the region (Exhibit 4). In this context, exorbitant growth in mainland China, the world s most populous country, was the primary driver for the rising disparity in inter-country inequality. 1 The Gini coefficient can theoretically range from zero to one, with zero corresponding to complete equality and one to complete inequality. 3

4 Exhibit 3: Gini coefficient of Asia Exhibit 4: Decomposition of Asia s inequality 100% 80% 22.6% 29.6% 60% % 20% 77.4% 70.4% 0.2 mid 1990s late 2000s Sources: Asian Development Bank, Hang Seng Bank 0% Within-country inequality Between-country inequality Sources: Asian Development Bank, Hang Seng Bank Still, the decomposition analysis suggests over 70% of the inequality in Asia arises from uneven income growth within the country. During the first decade of the 21st Century, most of the Asian countries witnessed a substantial increase in wage inequalities. Of the 13 Asian economies under our review, eight experienced an increase in income dispersion (Exhibit 5). Among the areas studied, mainland China (+0.11), Indonesia (+0.10), Sri Lanka (+0.08) and Hong Kong (+0.05) have seen sharper rises in their Gini coefficients. Exhibit 5: Gini coefficient in selected Asian economies s 2000s South Korea Pakistan Bangladesh Taiwan Vietnam India Indonesia Thailand Sri Lanka Philippines Mainland China Malaysia Hong Kong Sources: Asian Development Bank, Hang Seng Bank What drives the changes in inequality Since the period of rising inequality has been associated with rapid growth and unprecedented economic liberalization, much of the debate has focused on the roles that economic development and globalization have played in explaining inequality patterns. Stripping out the cyclical influences, three major explanations for rising income dispersion have been put forward. 4

5 1. Stage of development is a determinant for income inequality As predicted by the Kuznets hypothesis (1955), income inequality rises when population shifts from traditional to modern sectors. Until the level of labour employed in modern sectors has reached a certain level and the pool of surplus labour has exhausted, the trend reverses. Drawing on macroeconomic data, there appears to be an inverted U-relationship between income inequality and income level for Asian economies (Exhibit 6). Income inequality is more severe in the middle-income countries (e.g. mainland China and Malaysia) than the economies at both the lower (e.g. Bangladesh and Afghanistan) and upper end (e.g. South Korea and Taiwan) of the income scale. Subject to the period considered, GDP per capita explains around 50% of the variation in Gini coefficients across Asian countries in late 2000s. Exhibit 6: Gini coefficient and income level of Asian economies (2008) 0.5 Gini coefficient R 2 = GDP per capita (USD) Sources: IMF, Asian Development Bank, Hang Seng Bank 2. North-South technological transfer creates a premium for knowledge workers over unskilled workers Changes in global inequality are sometimes portrayed as a result of North-South technological transfer. As developing countries continue to adopt new technologies from advanced economies, proponents of this argument state that wage differentials are to a larger extent determined by educational attainments and skill levels of the workers. To examine the validity of this argument, one has to look for the change of skill wage premium over time. The World Bank (2010) estimates that skill premium 2 of workers in Asian countries has increased over the last decade, with Thailand as the only exception (Exhibit 7). The rise in skill premium, accompanied by an increasing supply of skilled labour, hints that dependence on foreign technology leads to higher degree of skill bias. 2 Skill premium defined as percentage change in hourly wage from being a skilled worker in comparison to being an unskilled worker 5

6 Exhibit 7: Skill Wage Premium Mongolia Mainland China Cambodia 9.1% 29.9% 27.4% 27.0% 47.9% 71.4% Vietnam Thailand Philippines Indonesia 9.0% 28.1% 29.6% 27.3% 54.4% 66.2% 65.0% 83.7% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 1990s 2000s Sources: World Bank s Policy Research Working Paper 5379, Hang Seng Bank 3. The upsurge in wage inequality is a direct consequence of trade liberalization In the final quarter of the 20th Century, country after country liberalized their trade accounts and integrated with the global economy. Trade theory predicts the return of the factor used most intensively in goods production will rise following trade liberalization. In other words, specialization in manufacturing will benefit the better off in developing countries, if skilled workers in developing countries are more comparable in their skills to unskilled workers in advanced countries. Yet, empirical evidence suggests the trade liberalization, per se, falls short as a dominant explanation for the change of income pattern in Asia. Analysis of cross-country data reveals that openness to trade has insignificant distributional effect in Asia (Exhibit 8). Some export-oriented economies in the region have had fairly low levels of inequality in income. The prime examples are Thailand and Cambodia. If we control for the impact of different income levels, the explanatory power of trade openness is even lower. In light of this result, the role of trade liberalization on determining income distribution appears to be overstated. Exhibit 8: Gini coefficient and trade-to-gdp ratio (2008) 0.5 Gini coefficient Trade-to-GDP ratio (%) Sources: Asian Development Bank, Hang Seng Bank 6

7 The path going forward Looking ahead to the next decade, income discrepancies between countries are set to narrow due to the catch-up growth in Developing Asia relative to that in the Mainland. Although Developing Asia is unlikely to rival the Mainland in absolute GDP terms even over a longer time horizon, it could overtake the Mainland as the world s fastest-growing region. Meanwhile, the IMF projects that nominal GDP growth of Developing Asia will out pace that of the Mainland by 0.5 percentage point per annum during the period , with an average growth of 10.2% per year (Exhibit 9). Equally concerning is the unequal distribution of income within countries. Following the line of reasoning mentioned above, income inequality within country is forecast to rise in most parts of Developing Asia. The projected rise in inequality can also be broken down into two parts: (1) economic transformation and (2) a shift of job creation linked to technological change. To begin with, our cross-country study indicates that the Kuznets s curve turning point occurs when GDP per capita reaches USD7,000-8,000 (Exhibit 6). Even considering the economies with higher income levels such as mainland China, Thailand and Indonesia, Developing Asia could only reach the turning point by late 2010s (Exhibit 10). Ceteris paribus projected changes in the economic structure will exacerbate the problem of inequality. Exhibit 9: Projection on nominal GDP growth (per annum) 24% 20% 16% 12% 8% 4% 0% 13.8% 21.9% 10.2% Developing Asia ex Mainland China 9.7% Mainland China Sources: IMF, Hang Seng Bank Exhibit 10: GDP per capita (USD, 2011) Singapore Hong Kong SAR Korea Taiwan Malaysia 9700 Mainland China 5414 Thailand 5394 Indonesia 3509 Sri Lanka 2877 Philippines 2223 Bhutan 2121 India 1389 Vietnam 1374 Pakistan 1201 Cambodia 852 Bangladesh 678 Nepal 653 Afghanistan Sources: IMF, Hang Seng Bank Moreover, both the willingness and ability to tap external knowledge and exploit the technology gap are still strong in Asia. Asia is currently in a more favourable position to take advantage of new technology in comparison with other developing economies, in term of openness, educational attainment, infrastructure adequacy, governance and business environment. Hence, we expect technological change to continue to drive polarization of employment and emerge as a prominent source of inequality in Asia for many years to come. 7

8 Policy challenge It might come as no surprise that the World Economic Forum has just named income inequality as a top global risk. On a somewhat encouraging note, Asian authorities recognize that a more equitable distribution of the fruits of economic progress require forces beyond the market alone. Confronting rising inequality is now a major national agenda in many Asian societies (Exhibit 11). Allowing for in-kind transfers, Gini coefficient of Asia is indeed notably lower than that of the economies with comparable income levels (Exhibit 12). Exhibit 11: Key policy statement on building inclusive institution Country Objective Mainland China Seek to build a harmonious society, with greater emphasis on the quality of growth India Malaysia Thailand Indonesia Philippines Committed to a growth process that yields broad based benefits and ensures equality of opportunity for all Adopt an inclusive development approach to ensure equitable access to economic participation Introduce the concept of sufficiency economy with a vision of equity, fairness and resilience Ensure the development plan aligns with the objective of development for all Achieve inclusive growth, create employment opportunities and reduce poverty Sources: Asian Development Bank, Hang Seng Bank Exhibit 12: Gini Coefficient (after taxes and transfers) ( ) Adjusted Gini Coefficient Asia (average) High-income countries (average) Middle-income countries (average) Low-income countries (average) Sources: United Nations, Hang Seng Bank While the desirability of interventions is no longer a matter of serious disagreement, relative focus on pre-market (e.g. labor market regulation and education) or post-market intervention (e.g. progressive taxation) remains open to debate. After all, what matters is the design of policy instruments, not only the total level of spending. 8

9 To meet the challenge of reducing inequality without stunting growth, we believe focus will be on promoting opportunities for moving up the income ladder or enhancing social mobility, rather than large-scale redistribution. It is likely to see the governments extend their efforts on achieving inclusive growth, including: An egalitarian expansion in the access to education and healthcare services; Introduction of subsidized wage program to help workers acquire skills in growing sectors; Investing in transport, communications and other infrastructure; Institutional redesigns with emphasis on eliminating the rigidities in labor and product markets; Improving small- and medium-sized enterprises access to financing; Reserving funds for conditional cash transfers. In any case, policy makers in Asia have shown stronger determination to strike a proper balance between efficiency and equity than they did in the past. Given the inequality has risen to the point that intensifying resistance to further liberalization and impairing social cohesion, these efforts to store social balance should be welcomed. 9

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