Editor's note: The 1998-99 edition of the IDB report on economic and social progress in the region, Facing Up to Inequality in Latin America, examines why the region's societies are so unequal and suggests what can be done about it. The report was prepared under the direction of IDB Chief Economist Ricardo Hausmann. IDBAmérica's Daniel Drosdoff spoke with him on the eve of the report's publication.
IDBAmérica: We've heard a lot about Latin America having the highest inequality in the world. What is the report saying that is new?
HAUSMANN: Very often when people think of inequality in Latin America they think of something like the top 15 families. But even if these 15 families existed, they would not account for the high-income inequality in Latin America from a statistical point of view.
What makes Latin America the most unequal region in the world is not the top 0.001 percent of the population but the top 10 percent. Here we have people with average incomes eight times greater than those in the bottom 30 percent. The difference is even more dramatic when we look at households. This is because in the top 10 percent nearly all adults work, but only one adult per family works in the bottom 30 percent.
Income is one major factor in inequality. Another is education. People in the top 10 percent have about 12 years of schooling, putting them at a greater advantage over the bottom 30 percent, where people typically go no further than the fourth or fifth grade.
A third key factor is the number of children per household. Those in the top 10 percent have fewer than two children, while those in the bottom 30 percent have twice that.
IDBAmérica: What are the principal reasons for Latin America's inequality?
HAUSMANN: There is a mix of reasons, such as stage of development, and what we might call "natural endowments," or geography.
Development really has five dimensions. The first is that as development proceeds, returns to capital decline. This is because capital becomes more abundant overall, while its share as a part of national income drops. At the same time, the share of income paid to skilled and unskilled labor increases. Latin America is now in the midst of this shift in income, from capital to labor, which improves the prospects for greater equality.
The second dimension is demography. Countries that have high rates of population growth also have high inequality. The lower the income, the higher the number of children. Again, fertility rates in Latin America are dropping.
Third is education. When relatively few get educated, such as in Latin America, inequality is high. But as more young people get educated and the older, less-educated generation passes away, inequality eventually starts to decrease.
Fourth is inequality that emerges from differences between rural and urban societies. In the countryside, most people are generally equal. But people in urban areas on the average have much higher incomes than in rural areas, so as urban areas grow, and you put the two together statistically, you get more inequality. In Latin America, there are four rural people for every six urban dwellers, accentuating this effect.
Finally, there is a process of formalization. As development proceeds, more people work in the formal economy, where wage differentials are smaller than in the informal sector. Latin America still has a very large informal economy.
IDBAmérica: What do you mean by natural endowments or geography?
HAUSMANN: We find a very strong statistical relationship between geographical variables and inequality.
We have found, for example, that tropical areas tend to have more inequality in income and land tenure. Also, countries that tend to export tropical products tend to be more unequal. One explanation may be that it's harder to work in the hot areas, but that would be an obvious oversimplification. Another possible explanation is the higher disease burden in tropical areas.
Also, typical tropical agriculture is plantation agriculture, which is profitable because of its larger economies of scale and production. This leads to larger land holdings and more concentrated ownership.
IDBAmérica: What must Latin America do to reduce its burden of inequality?
HAUSMANN: One thing that must be done right now is to take advantage of a unique demographic window of opportunity.
Fertility rates in Latin America are coming down, which means that the rate of increase in numbers of workers is higher than the rate of increase of children. As a result, a larger share of the population is working.
Our generation has an incredible opportunity to do three things: we can work more, we can save more and we can educate more.
But the next 20 years will be decisive, and it is an opportunity that comes only once. Some countries, such as Uruguay and Argentina, already have gone through this demographic stage, and they will not get a second chance.
IDBAmérica: What do your studies suggest in terms of concrete policies?
HAUSMANN: One thing is that we need policies that give skilled labor a return that is great enough to justify the necessary training and education, especially the female work force.
When the price of skilled labor is sufficiently high, families have an incentive to choose more labor market participation. As more women enter the market, families choose to have fewer children, and they invest proportionately more in schooling.
Paradoxically, educational levels are lowest in those countries where the returns for education are highest. One explanation is that it is just too difficult for poor people to go to school.
Imagine yourself a woman managing a home without running water, without electricity, and without good access to transportation. After doing the household chores, you have no time or energy left to enter the formal labor market. This is why it is so crucial to have policies to improve water and electricity services, and increase access to transportation.
IDBAmérica: How about changes in labor policy? Is there a link between labor policies and inequality?
HAUSMANN: In general, Latin America's labor legislation is antiquated, and moreover, it has been written by men, not women. Partly because of this, women have a harder time getting into the formal labor market than men.
Current labor legislation restricts flexible work hours, part-time work and special hours, all of which are vitally important to a woman with responsibilities at home. If you don't work the standard hours, then employers must pay extra hours and charges, making it prohibitively expensive to hire women.
Secondly, you have relatively generous provisions for maternity leave, whose costs are supposed to be born by the employer. Consequently, employers prefer to hire men, or they hire women at a lower wage. If the wage is unattractive, women prefer to work in the informal sector or stay at home.
IDBAmérica: On the one hand your report rejects populist policies, but on the other hand it says that greater equality in Latin America is better for growth. How do you resolve this apparent contradiction?
HAUSMANN: Let me say some things about populist policies.
Take the minimum wage. In Latin America the minimum wage that is on the books is not received by people in the bottom 30 percent of the income scale. Paraguay, one of the poorest and most unequal countries in the hemisphere, has the highest minimum wage. We find that the minimum wage has very small--maybe even negative--distributional effects.
Similarly, we argue that the attempt to build progressive taxation on a shaky foundation of inefficient tax collection systems has resulted in very little revenue actually collected. That leaves the government with two choices, both of them bad: either provide inadequate services, or resort to the highly regressive inflation tax.
What we are saying is this: create an efficient tax system that collects with relatively broad taxes and low rates. The progressivity of the fiscal system will come mainly from the spending side, by focusing on education, health and basic infrastructure. The reason is because the richest top 10 percent in Latin America doesn't use public education and doesn't use public health.
IDBAmérica: This year's report champions greater income equality as good for economic growth. Isn't this at odds with some classical trickle-down theories that favor concentration of income as a precondition to investment and growth?
HAUSMANN: Our view is that inequality harms the ability of the political system to undertake policies that promote growth. It leads to societal conflicts. Beyond that, countries may want a more equal society because they perceive that it's a good in itself.