Chapter

11 Equity Issues in Latin America

Editor(s):
Ke-young Chu, Sanjeev Gupta, and Vito Tanzi
Published Date:
May 1999
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Author(s)
Enrique V. Iglesias

Thank you very much for giving me the opportunity, once again, to join a discussion at the IMF on the important topic of income distribution. This issue continues to command the close attention of policymakers throughout Latin America and of the Inter-American Development Bank (IDB). I remember that when we tackled this issue at the conference held here in 1995, I told you that I was brought up—professionally—in the United Nations Economic Commission for Latin America and the Caribbean (CEPAL), where we believed that growth and equity were perfectly compatible. Well, experience has taught us that there is nothing axiomatic about that relationship.

Since the 1950s, various theories have been advanced to explain the relationship between growth and equity. For example, some have argued that a skewed income distribution promotes economic growth because the rich save and invest a higher proportion of their income than other groups do. The Latin American experience, however, was that the high savings of the rich, in general, tended to be invested abroad without any benefit in terms of higher growth for the domestic economies. Similarly, international experience fails to confirm the hypothesis that income distribution deteriorates as growth accelerates; on the contrary, countries with less concentration of income tend to grow faster.

After many years of trial and error, we in Latin America have learned a lot about how to grow, to stabilize our economies, and to increase efficiency. But we still do not have a full understanding of how to transform economic efficiency into broadly based social welfare.

Current State of Affairs in Latin America

The first point I want to make is that, taking a long view, the distribution of income in Latin America has not improved. During the 1950s and 1960s, and the beginning of the 1970s, we witnessed a noticeable improvement. However, the debt crisis of the 1980s led to a reversal of those gains, as the income share of the poorest decile deteriorated while the top 10 percent of the population enjoyed an increase. In the 1990s, countries throughout Latin America have pursued structural reforms, with the result that the region has blossomed into an emerging market strongly attractive to investors, both domestic and foreign. We have, for the first time in 40 years, single-digit inflation; increasingly open economies; and a demonstrated capacity to withstand severe external shocks.

Nevertheless, improvement in social conditions is lagging far behind the progressive transformation of our economies. Why is this happening? The facts are disturbing: 25 percent of all income is received by only 5 percent of the population, and 40 percent by only 10 percent of the population. These proportions are comparable only to those of Africa, where average per capita income is one-half that of Latin America’s. I want to highlight this contradiction. Of the almost 500 million people in Latin America, one-third live with a per capita income of $2 per day. If there were a closer fit in Latin America between the pattern of income distribution and the level of economic development, the incidence of poverty would be less than one-half of what it is today. Latin America’s per capita income is comparable to that of Eastern Europe. The incidence of poverty in Eastern Europe, however, is only 7 percent, whereas in Latin America it is 33 percent. Similarly, if the income distribution of Latin America were similar to that of Southeast Asia, the number of people living in poverty would be only one-fifth of what it is today.

This seriously inequitable distribution of income is ethically unacceptable and could also threaten the preservation of Latin America’s democracies. Survey results show that in those countries with a more uniform distribution of income (for example, Chile, Costa Rica, and Uruguay), a high percentage of the population considers democracy preferable to any other form of government. In many other Latin American countries, where democracy is taking root again and economies are undergoing deep structural reforms, a growing number of people are not sharing in the benefits and are questioning the value of democracy.

Therefore, we have an issue that goes beyond economic and social implications to the political sphere. The economic reforms in Latin America have been serious and painful, but have not produced in many cases the widespread social gains that would help to consolidate democratic institutions. The richest of Latin America are very rich, but the distribution of income among the remainder of the population is not very different from that of industrialized countries. The basic question is, why are Latin America’s rich so rich?

Three Factors Relating to Unequal Distribution of Income in Latin America

Education

At the IDB, we have examined three factors that could possibly explain Latin America’s unequal distribution of income. The first relates to education. In Latin America at the beginning of the 1960s, the (lifetime) average education for individuals above age 25 was 3–3½ years, about the same as in East Asia. Nowadays, however, the level in Latin America is about 5 years, while East Asia has forged ahead to between 8 and 10 years. Access to primary education in Latin America is comparable to that in East Asia, and enrollment rates for university are about the same, maybe even higher in Latin America. The major problem is in secondary education: the enrollment rate is very low compared with other countries, particularly those in East Asia. In Latin America as a whole, 90 percent of poor children attend school the first year, but by the fifth year only 63 percent of the school-age population remains in school and barely 15 percent by the ninth year. The dropout rate is especially alarming in Central America: only 32 percent of the school-age population remains in school by the fifth year, dwindling to 6 percent by the ninth year.

There is a strong statistical relationship between household income and the probability of remaining in school: dropout rates of the poor are very high while it is mostly the rich and the middle class who complete their education. Another problem that puts students from poorer households at a great disadvantage is that they have little choice but to attend public schools, and in most Latin American countries the quality of public education is poor at all levels. Therefore, the educational system is not supportive of social mobility in so far as workers’ incomes tend to increase with the number of years of formal schooling completed.

Wage Gap Between Skilled and Unskilled Workers

A second possible cause of strongly unequal income distribution in Latin America is the wage gap between skilled and unskilled workers, which is two to three times wider than in the industrialized countries. In East Asia, the wage difference between clerks and manual laborers is about the same as that in industrialized countries.

Why is there so great a difference between the wages of skilled and unskilled workers in Latin America?

According to conventional theories, the market-oriented, open economic policies adopted by many Latin American countries should be increasing the demand for the most abundant resource—labor, especially unskilled labor. But this is not happening. The wage gap increased over the last decade partly as a result of the changes in relative prices between tradable and nontradable goods and advances in technology, both of which have increased the demand for skilled labor. Again, education has played a major role in determining skill levels and, thus, income distribution. This explains why some of the successful countries in Latin America, in terms of economic reform and economic growth, are at the same time experiencing a worsening in income distribution between skilled and unskilled labor.

Inefficient Fiscal Policy

Fiscal policy is another factor that merits serious analysis to determine whether it contributes in a disproportionate manner to unequal income distribution in Latin America. Most Latin Americans think that the state must play a key role in the distribution process: as many as four out of five consider it the government’s responsibility to reduce the gap between rich and poor.

First, let us look at government expenditure. In industrialized countries, which have better income distribution than other country groups, government expenditure represents 40 percent of GDP—more than in any other country group. However, there is no evidence that increasing government expenditure would necessarily improve income distribution. In fact, many Latin American countries have a heavy state presence and unequal distribution, while there are others with smaller governments but with better income distribution. Although public expenditure in Latin America is substantially below the norm (20 percent of GDP versus a predicted level of 30 percent given its GDP), the problem seems to be not so much the size of government, but inefficient expenditure in areas such as education, health care, and social security.

In Latin America, the tax effort is also below the expected level. This is particularly so for income and property taxes, where collections are equivalent to only 4.5 percent of GDP—just above one-half of the expected level. Poor administration and a culture of evasion result in low income tax collection even in cases where maximum marginal rates have been lowered to 25 percent.

Policy Implications

What do these three factors imply for policymaking? The first conclusion is that strong emphasis must be put on the development of human resources. Clearly, in Latin America an important element of any strategy to reduce poverty and improve income distribution is to develop an accelerated program of education—stressing quality and broad access. I was encouraged to hear the presidents and heads of state of the Americas strongly emphasize education at the 1998 Santiago Summit.

Uruguay is a small country but it is the only country in the region that has improved its income distribution over the last decade. Why? I believe that Uruguay has the same Gini coefficient as Denmark because it has had a free, universal system of education since the last century.

The second policy implication is related to the reform of labor markets. Past efforts to protect employees have often created rigidities that, in turn, fostered informal or casual employment. In general, wage levels are lower in the informal sector, especially for unskilled workers. Throughout the region there is a need to examine labor laws and practices in order to reduce rigidities and minimize disincentives to employment in the formal sector.

The third policy implication is that the quality of delivery of social services must be improved. In recent years, steps have been taken to improve the quality of Latin America’s educational systems, and we have had some encouraging results. Teacher training has been improved; more management flexibility has been given to the schools themselves, and parents have greater involvement; and the need to set high educational standards and independent testing has been emphasized. The same applies to health, where there is tremendous room to improve the efficiency of public expenditure by increasing the commitment and participation of the civil society.

The IDB is also studying asset distribution and access to credit, both of which are connected to the issue of income distribution in Latin America. Land distribution in some of these countries remains a problem, although it does not seem to have the policy visibility that it had in the 1960s in the context of the Alliance for Progress. As far as the operation of financial markets is concerned, the 40–50 percent of the people that make up the informal sector (about 60 million micro and small economic units) would greatly benefit from increased access to credit. This is essential to facilitate the small investments needed for them to increase their productivity and, therefore, would achieve both social and economic objectives.

Finally, let me stress that growth and stability are indispensable for social improvement. The case of Brazil is very telling: 30 million people rose above the poverty line as a result of the economic stabilization achieved through the Real Plan. At the IDB, we recognize the imperative of accelerating action to reduce poverty and inequality. We are closely examining experiences in our own region and elsewhere to be better placed in advising governments in Latin America in the design and implementation of policies to ensure that the benefits of the restructuring of our economies are spread more widely and equitably.

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