Wednesday, December 2, 2015

Why economic convergence matters in today’s globalized world

In his fine book The Upside of Down: Catastrophe, Creativity and the Renewal of Civilization, professor Thomas Homer-Dixon refers to the projected divergence in average income per capita between the rich and poor countries.

Even if one assumes that the low income countries grow for the foreseeable future at much higher rates than the high income countries, because the current gap in per capita income is so large, the gap widens for many decades to come before convergence finally sets in well into the next century, if not later.

In other words, by 2015 the rich countries are so far ahead of the rest of the world that, except for a handful of countries with incomes very close to the income of the poorest rich country, no one else has a realistic chance of converging, as Taiwan (China) and South Korea did during the post-World War II period. This phenomenon, of widening income gaps in the future notwithstanding the presence of higher growth rates in the poor countries today is what Homer-Dixon (p. 189) calls “the dirty little secret of development economics.”

There are several problems with such widening gaps. A first obvious one is that the larger the gap, the more difficult it is to make the jump. Taiwan (China), Singapore and Korea did it and Chile has been admitted to the OECD—but these cases of upward mobility are few and far between. Landes (1990) thinks that an important constraint is knowledge and know-how, which cannot be easily acquired.

The development of Taiwan’s human capital during its transition into the rich economy club was an extremely complex process. Although seemingly a disadvantage at the time, the brain drain of the 1960s and 1970s—when some 50,000 of the brightest young Taiwanese went overseas (principally to the United States) for university and advanced studies—allowed Taiwan to build a large pool of qualified and experienced people before its economy was ready to absorb them.

From 1985 onwards, incentives drew them back to Taiwan as entrepreneurs, to create start-ups in the science parks, or to take up research, academic, and management positions, bringing not only their knowledge and experience, but also their networks of contacts and working relationships with leading international companies, and enabling today’s Taiwanese universities to educate its own manpower for continuing expansion at home.

These informal networks, supplemented by overseas offices of various institutes and research centers, have facilitated technology transfer, innovation, and strong entrepreneurial relationships. In other economies, the story of training and higher education has often been, as noted by Landes, “the permanent loss of talent.”[1]

Being far behind creates a difficult context for the implementation of sound policies. The populations of poor countries can readily and accurately estimate—because of the power of communications technologies—how far back they are vis-à-vis the rest of the world, particularly the rich economies of the industrial world. This is likely to create unrealistic expectations of catchup and, in turn, force governments to favor a populist path, instead of the deliberate, gradual and at times difficult path chosen by the few successful cases of upward mobility.

When the gap is so wide that the possibility of catching up within a generation or two is no more than a pipe dream, governments may find it difficult to engage the public in the pursuit of cautious, coherent policies. “Lateness is the parent of bad government” [2] is how Landes puts it, where he uses the noun “late” to mean late entry into the development process, captured by a low per capita income.

Furthermore, the combination of widening income gaps between countries and the globalization of ideas, knowledge, access to information and awareness of others’ living standards provides powerful incentives for the movement of people across international boundaries.

If to this we add the likely future effects of climate change on vulnerable populations (developing economies are far more dependent on agriculture, which will be hard hit by climate change) and the sort of chaos and generalized upheavals we have seen in recent years in a growing number of countries (e.g., Syria, Iraq, Yemen, Afghanistan, Mali, Venezuela, to name a few), then those incentives are magnified and migration risks becoming an even bigger challenge.

Some economists (e.g., Paul Collier) have highlighted some of the difficulties associated with a segmentation of the world into two broad regions, one characterized by either high income or at least positive economic growth and another where some 60 countries with a combined population in excess of 1 billion are not only falling behind but often falling apart, becoming exporters of “violence and people instead of goods and services,” [3] thereby beginning to pose a security threat to the rest of the world.

Collier argues that economic development is very much about giving ordinary people the hope that, at some point in the not too distant future, their children will have access to the same opportunities available to children in Germany and Sweden and other rich countries. The notion of convergence is very much at the heart of much of what we do at the World Bank, the idea that we will gradually see in the developing world the unfoldment of the policies and institutions that have propelled the rich countries to levels of wealth and prosperity never before reached in the last several thousand years of recorded history. In the absence of that hope, smart, motivated people will seek to escape from their societies and try to look for those opportunities elsewhere.

This creates a huge challenge for the recipient countries if the numbers are large enough to put strains on rich country budgets and infrastructures and it can deprive the sending countries of essential human capital. Hence the central importance of the World Bank’s current focus on shared prosperity; it matters not only for development outcomes, but it also clearly has a security and political dimension that goes far beyond a narrowing of income differentials.

[1] Landes, David S. 1990. “Why Are We So Rich and They So Poor?”, American Economic Review, Vol 80, No. 2, Papers and Proceedings of the Hundred and Second Annual Meeting of the American Economic Association, p. 1-13.
[2] Landes (1990), p. 12.
[3] Collier, Paul. 2007. The Bottom Billion: Why the Poorest Countries Are Failing and What Can Be Done About It, Oxford University Press, p. 12.

Thursday, July 30, 2015

Equality of opportunity as an engine of prosperity

EEOC 35th Anniversary Art Contest
Chelsea Lapp, Age 11
Sixth Grade
Flying Hills Elementary School
El Cajon, CA
We have learned much over the past several decades about the connection between gender inequality and economic growth, particularly when we talk about inequalities in education and employment. Inequalities in education, for instance, artificially reduce the pool of talent which societies can draw from; by excluding qualified girls from the educational stream and promoting less qualified boys, the average amount of human capital in a country will be reduced and this will have an adverse impact on economic performance. We also know that the promotion of female education leads to lower births per women, not only because educated women will have greater knowledge about family planning but also because education creates greater opportunities for women that may be more attractive than childbearing.

Lower fertility levels help reduce child mortality and expand the range of educational opportunities available to the next generation. All of these factors combine to boost economic growth. Indeed, the effects of lower fertility levels associated with improved female education have long-lasting effects and deliver a “demographic dividend” a couple of decades later. With reduced fertility levels the working-age population will grow more rapidly than the overall population and this will boost per capita economic growth.

Yet another powerful driver of economic growth associated with the narrowing of employment gender gaps has to do with the “bargaining power within families.” Not surprisingly, when women work and earn income as a result, they will be more empowered within the home. Beyond the direct personal benefits to her, the economics literature has identified a number of other favorable effects such as higher savings, more productive investments and better use and repayment of credit, all of which are beneficial for economic growth. Other studies have shown that with greater female power within the household there will be higher investments in the health and education of children, thereby planting the seeds for the accumulation of human capital in the next generation.

A further avenue of influence has to do with growing evidence that women workers are less prone to corruption and nepotism than men workers. The criminology literature, for instance, has long established that “the most consistent pattern with respect to gender is the extent to which male criminal participation in serious crimes at any age greatly exceeds that of females, regardless of the source of data, crime type, level of involvement or measure of participation.” [1] More recently, a survey of 6,500 companies carried out in the United Kingdom looking at the gender composition of company boards showed clear evidence that companies with greater female participation in boards were less likely to be hit by governance scandals involving bribery, fraud and other factors likely to depress business confidence.[2] So, boosting the employment of women is likely to be beneficial for economic growth through improvements in the quality of governance.

Of course, while governments have played a central role over the past century in the creation of a legal framework that has placed important limitations on women’s ability to contribute meaningfully to the economy or that have shaped in some adverse way her economic surroundings (see the Women, Business and the Law report for a detailed compendium across 143 countries of the ways in which this has been done), there are many other forms of discrimination embedded in the law, that go well beyond issues of gender.

Article 20 of the Constitution of Iran establishes that all citizens of Iran have to be "in conformity with Islamic criteria." Hence, members of the Baha’i community, Iran’s largest religious minority, are denied access to schools and universities, barred from public sector employment, and face severe work restrictions in virtually every other sector of the economy. In Lebanon, groups such as Baha'is, Buddhists, and Hindus may own property and assemble for worship, but may not marry, divorce, or inherit property within the country. The Uganda Anti-Homosexuality Act of 2014 punishes "aggravated homosexuality" with life imprisonment and the "offence of homosexuality" with a prison sentence of up to 14 years.

There is clearly a role for government to create the enabling conditions for a sound economy and an equitable society that makes efficient use of the natural, economic and human resources available to it to meet the needs and ensure the well-being of everyone. Poverty is one indicator of government failings in this area. Despite the rapid growth experienced in several developing countries over the past few decades, more than 1 billion people still live in extreme poverty, and inequality is increasing around the world.

The World Bank has committed to achieving the twin goals of eliminating extreme poverty and boosting shared prosperity. These goals go hand in hand with equality of opportunity and the inclusive participation of all segments of society in the economic and social spheres. Poverty is often greatest in traditionally marginalized groups, and various forms of discrimination can greatly depress the prospects for its alleviation.

The most sustainable path towards ending extreme poverty and promoting shared prosperity is through creating an inclusive society, allowing everyone, including traditionally marginalized groups such as ethnic, religious, and other minorities, the same opportunity to participate in and benefit from the economy. Governments have a critical role in creating a foundation for equality of opportunity, both through dismantling laws, regulations and policies which actively discriminate against certain groups, and through adopting and promoting mechanisms enhancing the enforcement of anti-discrimination legislation.

Prosperity involves more than just increasing and distributing wealth. Human well-being includes social, cultural, ethical and spiritual dimensions. The diversity and additional perspectives contributed by presently marginalized groups can, when allowed full expression and participation, enrich the community and society and add to collective prosperity. Equality of opportunity not only prevents a waste of human resources and capacities, but also opens the potential to even higher levels of social and economic well-being.

[1] From a study conducted by the National Academy of Sciences of the United States, cited in Swamy, Azfar, Knack and Lee (2001).
[2] Financial Times (March 9, 2015).

Thursday, May 28, 2015

Unpacking the drivers of inequality relationship between growth and income inequality is more complex than the one between growth and poverty, and has been the subject of considerable study.

An early contribution in the 1950s by Nobel Prize-winning economist Simon Kuznets, for instance, noted that at least two forces tended to increase inequality over time. One was the concentration of savings in the upper-income groups; he observed that in the United States the wealthiest 5 percent of the population accounted for close to two-thirds of total savings.

A second factor, which has been a universal characteristic of development over the past century, was the gradual shift away from agriculture. Between 1991 and 2001, for instance, more than 8 million people left agriculture in India. Between 1965 and 2000 the share of the labor force employed in agriculture fell from 49 to 21 percent in Brazil, from 26 to 5 percent in Japan, from 55 to 11 percent in Korea, from 81 to 47 percent in China, and it fell to 2 percent in the United States.

As people moved from villages to cities, from agriculture into industry, they moved from a low productivity sector to one of higher productivity and this heightened income disparities. Incomes tended to be more equal in agriculture, but as people moved to the cities this meant the share of the population where income was more unequal increased.

Other factors were also at work, some of them exerting an influence in the opposite direction. One was the increasing role of government and the implementation of policies intended to reduce income disparities, whether through inheritance taxes, mechanisms for social protection,  or critically, the extension of publicly financed education to large segments of the population, including girls.

In some countries—particularly in East Asia—land reform also strongly contributed to diminished income disparities and, may have unleashed rapid economic growth and convergence. The role of government policy implied that, often, there was a growing distinction (or gap) between inequality in living standards and inequality in incomes, with the former often boosted through the redistributive attributes of the government budget. Demography and migration had an impact on the distribution of income too.

At least as important was the impact of technology and the dynamic forces associated with industrialization. New technologies, and associated processes meant that those with the skills to handle new machinery or read instruction manuals—the vast majority of them men—could command much higher wages, and this inevitably led to a widening of income disparities between the genders.

Moreover, this phenomenon was self-reinforcing. Those who, because of their skills commanded higher wages, could afford to get loans to start new ventures and save more, accumulated a growing share of the country’s wealth, something that provided additional opportunities for profitable investments and create new companies. In countries with weak institutions, ineffective regulations and poor law enforcement, this often translated into expanded opportunities for the unscrupulous, particularly those with access to the levers of political power.

The expansion of huge wealth stemming from corruption has surely been a regular feature of economic development during the past couple of centuries. Where growing income disparities were partly (or mainly) due to corruption and the abuse of power the result often was growing social tensions, political instability or, at the extreme, civil disturbances. However, absent corruption, the result was often the creation of new industries and the emergence of a powerful culture of innovation.

The relationship between education, training and a skilled labor force and inequality is strong and dynamic. At one level, as education spreads and a growing share of the population partakes of its benefits, one might expect a leveling off of income inequality. There is evidence that this is exactly what happened in England in the 19th century, widening at first as the process of industrialization got underway and leveling off before the end of the century. (Benjamin Friedman argues in “The Moral Consequences of Economic Growth” that “Karl Marx’s claim that capitalism inevitably leads to ever increasing misery of the working classes, and hence to an explosive polarization of society, resulted from Marx’s myopic extrapolation of the widening inequality that accompanied England’s economic growth in the first half of the nineteenth century” (p. 349)).

However, there is no guarantee that this leveling off will be permanent. Since technological change is relative, the arrival of new technologies can, in principle, induce exactly the same sorts of changes which the introduction of simpler technologies had on skills-based wage differentials during earlier stages of the development process, leading, yet again, to rising income disparities.

Friedman (2005) offers an interesting analysis of the impact of outsourcing on income inequality. When an American manufacturer closes its plant in the United States and shifts it to India, American workers’ job losses will be offset by job gains in India. While some US workers may be able to find jobs elsewhere, others may not. Also, profits of the company are likely to rise because of the lower labor costs and the net impact, therefore, will be to widen inequality within the United States. Moreover, because some workers in India will now be earning wages well above the average in India, the closing of the plant in the United States will also widen inequality within India. However, inequality between the United States and India will have been narrowed. Friedman then asks: “If India’s average income draws closer to America’s, but in the process some Indians—in this example, the lucky workers who get the new factory jobs—pull ahead of their neighbors, is the net outcome a victory or a defeat for the cause of equality?”

We do not have a full understanding of the relative importance of all these factors—accumulation of savings, the declining role of agriculture, demography, government policy, migration, technological change, and globalization, to name a few—in shaping the evolution of income inequality. Some are obviously more amenable to change through shifts in the content of policies. Others—technological change being perhaps the leading example—are more exogenous in nature, responding to a combination of human creativity, the profit motive and, only at the margin, possibly government incentives and being, therefore, much more unpredictable in its impact.

One can reasonably assume that the importance of these factors will vary from country to country, depending on their stage of development, and that that importance will shift over time, in reflection of structural changes in the global economy. However, Kuznets was correct in arguing that without better knowledge of the evolution of income inequality and the factors that shape it, our own understanding of the process of economic development would be undermined as would our capacity to respond effectively to the challenges created by income divergence.