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Economic Growth is Not an Antipoverty Policy

Martin Ravallion

Development Research GroupWorld Bank

Conference: “Taking Action for the World’s Poor and Hungry People”Beijing, October 2007

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Two influential paradigms for anti-poverty policies

Paradigm 1: “Growth is sufficient”• “The only thing that really matters to fighting poverty

is economic growth” • Rising inequality is the unavoidable by-product of the

economic growth needed to reduce absolute poverty• “Inequality should not be a concern in poor countries”

Paradigm 2: “Growth PLUS”• Rapid poverty reduction requires a combination of

economic growth with pro-poor social policies.

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Questions for this talk

What does theory and evidence now suggest about the validity of paradigms 1 and 2?

Is there an aggregate equity-efficiency trade off?

What policies are needed for rapid and sustained poverty reduction?

Can those policies be neatly separated into “pro-growth” and “pro-equity”?

What about policy implementation? Can we make sense of systematic governmental failure, even when we know what to do?

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Inequality and growth revisited

Two stylized facts have emerged from the data

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-.8

-.6

-.4

-.2

.0

.2

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.6

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-1.6 -1.2 -0.8 -0.4 0.0 0.4 0.8 1.2

Difference in log mean

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ere

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g G

ini i

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Stylized Fact 1: Little or no correlation (either way) between changes in

inequality and rates of growth amongst developing countries

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-1.0

-0.5

0.0

0.5

1.0

-0.3 -0.2 -0.1 0.0 0.1 0.2

Proportionate change in survey mean

Pro

port

iona

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the

$1

/day

pov

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Stylized Fact 2: Poverty measures tend to fall with aggregate

economic growth

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Empirical caveats on SF1 and SF2

1. Some signs of a positive correlation since the early 1990s, though not very robust

2. Churning under the surface; gainers and losers at all level of living

3. Measurement errors galore! However, seems robust.

4. Conceptual confusions, e.g., relative vs. absolute inequality =>

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-15

-10

-5

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-0.2 -0.1 0.0 0.1 0.2

Annualized change in log mean

Annualiz

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-10

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-0.2 -0.1 0.0 0.1 0.2

Annualized change in log mean

Annualiz

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Absolute inequality

Relative inequality

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Dubious policy inferences from SF1 and SF2

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Growth is not a policy!

• Stylized Facts 1 and 2 do not tell us that growth-promoting policies will reduce poverty and have no effect on inequality.

• For that we need to establish that those policies:– do in fact promote growth, and– do not have systematic and strong distributional

effects favoring the non-poor

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Nor do SF1 and SF2 tell us anything about redistributive

policies• Stylized Fact 1 does not imply that policy makers

aiming to fight poverty in any given country can safely focus on economic growth.

• All SF1 tells us is that, on average, there as been little effective redistribution in favor of the poor.– It does not tell us that re-distribution rarely happens – or that distribution is unimportant to the outcomes for poor

people from economic growth – or that social protection policies are unnecessary.

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Inequality and the pace of poverty reduction

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The extent to which growth is pro-poor has varied enormously

between countries and over time

• With 95% confidence, a 2% rate of growth will bring anything from

– a modest drop in the poverty rate of 1% to – a more dramatic 7% annual decline

• Two proximate reasons:1. Distributional changes during growth spells

2. Differences in initial inequality

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1. Distribution changes a lot, and the changes matter to progress against poverty

– The median rate of poverty reduction is 10%/year in the countries with falling inequality

– and barely 1%/year in those with rising inequality

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-0.2 -0.1 0.0 0.1 0.2

Annualized change in log mean

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10%

1%

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The pattern of growth matters

• Growth can be far more pro-poor in certain sectors – Agricultural growth in China, helped by low land

inequality– Agriculture and (esp.) services sector growth in India– Services sector growth in Brazil

• Geographic imbalances in the growth process can also stall overall rates of poverty reduction.– India’s growth since early 1990s has not favored the

areas where poor people are concentrated– China’s growth has favored coastal areas over inland

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2. Even if distribution does not change, high initial inequality

impedes poverty reduction

How long will it take to bring the poverty rate down from 40% to 20% with 2% annual growth rate?

• Low-inequality country (Gini=0.30): 11 years.

• High inequality country (Gini=0.60): 35 years.

• Note: the argument works in reverse: high inequality protects the poor from negative macro shocks.

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A growth-equity trade-off?

Will the PLUS policies undermine growth and (hence) poverty reduction?

Do growth policies have adverse distributional effects?

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Theory: High inequality can be inefficient and (hence) retard

growth Economic theory now questions the old presumption

that there will be an aggregate trade-off.

Two main arguments:

1. Credit-market failures=> inequalities in wealth create inefficient allocations of investment opportunities.

• More poor people means more credit-constrained people and hence lower investment and growth

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2. Political economy• High inequality also makes it harder to achieve

efficiency-promoting economic reforms that require trust and cooperation

• In the long-run, resilient economic inequalities are reflected in political inequalities.

=>The institutions that develop in very unequal contexts are less conducive to the protection of property rights, innovation and growth (WDR, 2006)

Theory: High inequality can be inefficient and (hence) retard

growth

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• Good inequalities reflect and reinforce market-based incentives that foster innovation, entrepreneurship and growth

Good and bad inequalities

• Bad inequalities prevent certain segments of the population from escaping poverty; inequality of opportunity (WDR, 2006) – Geographic poverty traps, – patterns of social exclusion, – inadequate levels of human capital, – lack of access to credit and insurance, – corruption and uneven influence

• Bad inequalities are rooted in market failures, coordination failures and governance failures

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Evidence 1

• Countries with higher initial inequality experienced lower growth controlling for other factors– Concerns about these tests (aggregation biases,

omitted variables)– Sub-national and micro evidence still coming, but so far

more supportive of the hypothesis that high inequality is inefficient.

• But none of this is about policies per se!

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Evidence 2

• Mixed evidence on the distributional effects of growth-promoting policies– Trade reforms: Aggregate distribution neutrality (China,

Morocco,…) though strong horizontal inequality effects– Other reforms: Still much we do not know, though

methodological problems abound

• Even weaker is our knowledge about the aggregate efficiency impacts of successful redistributive policies

• The jury is still out

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Revisiting the separabilty case for

“Growth PLUS”• Neat if we could have one set of policies for growth

and one set for redistribution.• The claim: More rapid poverty reduction is possible

by combining the two. – Growth policies create economic opportunities– And growth makes it easier to finance progressive policies.– The PLUS policies help assure that the poor are able to take

up the new opportunities in a growing economy or to compensate those who can’t.

• However, the separability assumption is a strong one– We know that some growth promoting policies have

distributional effects– And that distributional policies have potential efficiency

implications

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Two country examples

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China: “Growth is sufficient” at work?

• Yes, rapid growth with rapid rise in inequality =>• But China’s story does not vindicate Paradigm 1• No sign of a poverty-inequality trade off

– The time periods of falling inequality saw more rapid growth– The provinces with more rapid growth did not see a more rapid

rise in inequality

• Pattern of growth was key: – Agriculture and rural development is far more poverty-reducing

than industry or services

– The bulk of the poverty reduction came from AGR reforms (household responsibility system, price reforms, lower taxes)

• Arguably there is a counterfactual development path for China with more rapid poverty reduction

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1980 1985 1990 1995 2000

Gini index(right axis, %)

Headcount index(left axis, %)

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Brazil: Growth PLUS at work?

• Services sector growth is more pro-poor than agriculture or industry

• Change in policy regime around 1994– stabilized prices + trade liberalization

• Pattern of growth switched away from the services sector; higher growth but less pro-poor pattern of growth

• A combination of higher overall growth and redistributive social policies meant a higher rate of poverty reduction post-reform

• However, overall pace of poverty reduction is still low.

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The challenge of implementation

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Implementation is probably easier in low-inequality countries

• We can probably identify pro-poor policies appropriate to a given setting

• Political implementation is the real issue• In low-inequality countries, high poverty will tend to

generate a demand for sound policies to fight poverty

poverty

pro-poor policies

the policy impact curve

the political implementation curve

A

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A “high poverty + poor policies” trap

in high inequality countries?• High poverty and inequality can be self-perpetuating

by impeding pro-poor policies

=> Multiple equilibria are then possible:

poverty

pro-poor policies

the policy impact curve

A

B

The big policy challenge: How do we move from A to B?

the political implementation curve may well be downward sloping in high inequality countries

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“Growth is sufficient” misses the point

And “Growth PLUS” is a patch-up at best

In conclusion:

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Neither paradigm constitutes an adequate poverty reduction

strategy • Given the diverse impacts of growth on poverty, it is

clear that something else is needed.

=> Growth PLUS

• However, this is still incomplete without a deeper understanding of:

1. the distributional impacts of growth-promoting policies.

2. the growth impacts of the PLUS policies.

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How to achieve more pro-poor growth?

• Develop human and physical assets of poor people• Help make markets work better for the poor, esp., for

credit, land and labor• Remove biases against the poor in public spending,

taxation, trade and regulation • Promote growth in key sectors (agriculture and rural

development; services)• Invest in local public goods in poor areas with

economic potential• Provide an effective safety net; short term palliative

and (possibly) a key instrument for long-term poverty reduction

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Monitoring and evaluation is key;

so is flexibility• Sensitivity to country context is crucial for assessing

what set of policies is pro-poor.• Continuous monitoring of progress and evaluation of

specific policies/programs is a crucial input to effective domestic and international efforts against poverty

• Lesson from China: Experiment with policy options; scale up the success, and drop the failures.