The UN Chronicle

Inequality and Economic Development

By Jomo Kwame Sundaram

A comparison of the last quarter century to the previous two decades—the 1960s and 1970s—reveals that economic growth slowed during the last quarter of a century compared to the previous period, often referred to by “Keynesians” as the Golden Age. Slower growth has had different effects on different segments of the world’s population, but has nevertheless led to greater inequalities, in part because of the withdrawal of the state. It has also meant a slower pace of poverty reduction. On the other hand, some countries of the South, particularly in Africa, have recently experienced some resurgence of growth. Despite that development, inequality continues to persist, particularly within countries.

Global inequality and poverty The phenomenon of jobless growth has spread, while much of the debate about reducing poverty still does not take serious account of the employment consequences of economic liberalization. The current discourse on trade liberalization sharply contrasts with the debate six decades ago when the International Trade Organization (ITO) was proposed to complement the two Bretton Woods Institutions.

Ambiguous trends in global inequality in recent years are attributable in part to international measures of inequality, which use average per capita incomes weighted for population for countries, and therefore do not capture intra-country income distribution. China’s population size and very rapid rate of growth in the recent period has tremendously effected measures of global inequality. Once China is taken out of the picture, there is a very clear upward trend in such inequality measures. Income per capita of developing countries has generally fallen behind, except in the case of Asia. However, when one takes out China, even the rest of Asia does not show much progress. There has also been a huge collapse of income in the former Soviet Union and Eastern Europe since in the 1990s.

Does inequality matter? Until the middle of this decade many commentators focussed on poverty, not inequality. This, however, has changed somewhat since 2005 with publications by the United Nations and the World Bank, which have refocused attention on inequality. The United Nations own contribution was a more critical analysis of The Inequality Predicament in the 2005 Report on the World Social Situation (RWSS), issued prior to the World Bank’s 2006 World Development Report.

There are serious problems with the measurement of inequality and poverty. For instance, the World Bank fairly arbitrarily and for reasons of convenience chose a one dollar a day poverty line, with 1993 as the base year. Indian economist Surjit Bhalla has argued that the World Bank has exaggerated poverty in the world to keep itself in business. Amartya Sen has warned that money-metric measures of poverty can be misleading; instead, we should look to other ways of measuring needs fulfilment.

These different definitions have correspondingly different understandings of what constitutes pro-poor growth. The World Bank would argue that any kind of trickle-down would constitute pro-world growth. As long as the poor are not worse off, that would be considered pro-poor growth. Nanak Kakwani has suggested that the poor’s share of income should increase faster than for others for growth to be considered pro-poor. Others like Woodworth and Simms have argued that for growth to be pro-poor, the poor’s share of total growth must increase more than their share of the population.

Poverty trends have changed very significantly, particularly in the last two decades of the twentieth century. The table captures some of the trends. Most progress in poverty reduction seems to have been in East Asia, whereas in much of the rest of the world, there has been little progress in reducing the number of poor, in spite of improved growth rates in some parts of the world.

Poverty is important for many reasons and a blight on human existence. Also, there is a very strong likelihood of conflict occurring among the poor. There is a strong relationship between the likelihood of civil conflict recurring and the depth of poverty.

Where do the existing inequalities come from? Angus Maddison has looked at trends in average income inequality over the last two millennia. Today’s inequalities are of fairly recent origin, beginning about five centuries ago and accelerating about two centuries ago with the Industrial Revolution due to increased growth in some parts of the world and consequently, greater divergence and unevenness in development.

The Industrial Revolution was made possible by significant transfers of capital from the Indian subcontinent and the West Indies. John Hobson, at the beginning of the late nineteenth century, identified the new imperialism with significant capital transfers from the centres of finance capital, particularly through the City of London to the rest of the world.

The period after the Second World War saw accelerated growth, not only in the North but also in the South, as a consequence of policies pursued after the war. Thus, the century and a half of divergence was reversed after the Second World War, in part as a result of decolonization, the beginnings of import substituting industrialization and efforts at agrarian reform and rural development.

A difficult and complex transition period began with the end of the Bretton Woods system, from around 1971. Increased fuel prices led to recycling petrodollars, resulting in very low real interest rates which, together with high commodity prices, made it possible for relatively high investments and growth to occur in much of the South.

The divergence between North and South continued to close in the 1970s. This period was one of high growth, but also high inflation in many parts of the world, especially in Latin America. The high growth in East Asia, which had already begun in the 1960s, also accelerated in the 1970s. Africa—the last region of the world to obtain independence—was probably most adversely affected because its import substituting industries had less time to become internationally competitive because decolonization was so recent. The 1970s also saw analytical counter revolution, as the 1970s stagflation in the West resulted in the rise of now liberal ideology and the decline of “Keynesian” economic policy influence.

There are major challenges for the future of economic development prospects. First, in the course of the twentieth century, the terms of trade have been moving against developing countries in at least three ways. The prices of primary commodities declined against manufactures during the 20th century. Second, the late Arthur Lewis noted the much greater decline of tropical agricultural prices in contrast to temperate agriculture. Third, developing country-manufactured export prices have declined compared to manufactured exports from developed countries. One contributing factor could be the strengthening of intellectual property rights. A consequence is what Jagdish Bhagwati has acknowledged as immiserizing growth.

Developing countries have also experienced the adverse effects of trade liberalization and international financial liberalization. In the last 5 to 10 years, many earlier advocates of international financial liberalization have come to acknowledge that “financial globalization” is not necessarily in the best interest of development. The claim of advocates that capital would flow from the capital-rich to the capital-poor has not materialized, except very temporarily in East Asia before the crisis of 1997-1998. Instead, there has been a net flow of capital from the capital-poor to the capital-rich; it is like opening a bird cage, expecting more birds to fly in than to fly out.

The second claim by advocates of financial liberalization is that the cost of funds would be lower. While it is true that the cost of funds has been low in the last few years, there is no evidence to suggest that it has actually declined because of financial globalization rather than due to other factors. The third claim is that volatility and instability would be reduced. While some old sources have declined, new sources of even greater volatility and instability have been introduced in their place—as is clear in the international financial turmoil experienced recently.

The evidence suggests that most foreign capital has very little, if any, positive developmental consequences. Arguably, some may actually undermine development for reasons which are now pretty well documented. Domestic financial liberalization, which is often considered a necessary counterpart of international financial liberalization, often has deflationary macroeconomic consequences, deprives Governments of counter-cyclical instruments and also undermines developmental financial institutions and more inclusive financial initiatives.

International economic governance The International Monetary Fund (IMF) was originally conceived as an international financial cooperative with a governance arrangement akin to corporate governance—one dollar, one vote—with a modest provision for basic votes shared equally by member countries. In 1944, there were 44 members who shared 11.3 per cent of total votes, known as the basic books. IMF membership now is 184, while total basic votes have declined to 2.2 per cent. The recent offer by the outgoing IMF MD countries to developing countries is to double this from 2.2 to 4.3 per cent.

The World Trade Organization (WTO), at one level, is ostensibly a far more participatory and democratic organization. WTO was created slightly over a dozen years ago, following the failure to create the ITO in 1948, to succeed the General Agreement on Tariffs and Trade (GATT) as a temporary compromise, which lasted almost half a century of negotiations. Many of those rounds recognized that there are winners and losers from trade liberalization, and that losers need to be compensated and trade liberalization should be voluntary, not coerced. However, the same principle was never applied at the international level.

This has turned out to be the fundamental problem with WTO, which they are trying to overcome with the “aid for trade” initiative. Three features have made it a far more problematic institution than its predecessors. First, there is no longer the option of choice. As a member of the WTO, a country basically makes a “single commitment”. It is an “all or nothing deal”. Second, a whole range of new issues have come into play. Trade-related investment measures came under discussion and trade-related intellectual property rights are more important at WTO than at the World Intellectual Property Organization (WIPO). Third, the dispute settlement mechanism is biased towards those countries with the legal and other resources to be able to pursue trade negotiations and dispute adjudication.

Very modest concessions have been made to developing countries so far despite labelling the Doha round developmental. Most benefits would accrue to developed countries, and even among developing countries only a few would benefit significantly from trade liberalization. Some ostensible benefits are actually quite misleading. For example, India is supposed to benefit from agricultural trade liberalization. In fact, India has seen over a thousand suicides of farmers suffering from usurious debt compounded by problems of crop failure. These problems will only become much more onerous with lower prices of food coming in from abroad. Urban consumers would benefit at the expense of farmers and their families.

There is now a broader consensus about the need to respect national policy space, about the need for countries to be able to devise the institutions and policies in their best interest. This is now the most important common underlying issue affecting economic development being negotiated on a number of different fronts.

Biography

Jomo Kwame Sundaram is Assistant Secretary-General for Economic Development in the United Nations Department of Social and Economic Affairs. The article is adapted from his address at Tufts University on receiving the 2007 Wassily Leontief Prize for Advancing the Frontiers of Economic Thought.

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