Poverty and Economic Growth: Does Pro-Growth mean Pro-Poor?
Poverty can grind down countries and people. Almost 15 years on from the Millennium Development Goals (MDGs), the debate rages on, with causes and remedies still surrounded by contention. The question many development economists are asking is: do pro-growth economic policies mean pro-poor? For if the answer is yes, then we can argue that poverty reduction policies should have an economic growth bias and the implications can be far reaching, affecting some of the most vulnerable people in society.
To underline the scale of the problem, globally, poverty remains remarkably high, with little progress made in Sub-Saharan Africa, according to the World Bank data (Exhibit 1).
Exhibit 1: How Poverty has Evolved - 1985 to 2012
Even the most advanced economies cannot escape the debate. “The best anti-poverty program is economic growth” said Paul Ryan, the US Congressman, recently in a Wall Street Journal article, capturing the pro-growth side of the argument. In response, The New York Times’ senior economics correspondent, Neil Irwin, notes that “economic growth isn't leading to less poverty”, with income for people on the edge of poverty remaining low.
However, reality is much more complex. Firstly, pro-growth can either mean reducing inequality, that is, enacting policies that increase the income of the poor relative to the non-poor; or it can mean increasing the absolute income rate, so that the income increase is at a level that lowers the overall number of people living below the poverty line. How we choose to define “pro-growth” will determine the policy prescriptions at our disposal.
The World Bank prefers to use the absolute definition, noting that the relative definition has “limited operational use”, since it “places a premium on reducing inequality through growth more than reducing poverty.” For example an “economic contraction could be pro-poor if the incomes of poor households fall by less than those of non-poor households — despite the fact that poverty has not fallen.”
The economic rationale for focusing on inequality is clear. As Keynes demonstrated, inequality can cause poor households to increase consumption by borrowing more; and non-poor households to lower consumption and increase savings, leading to economic booms and busts. Such economic imbalances can undermine future generations and cause political uncertainty.
In What Makes Growth Sustain? Berg, Ostry, Zettelmeyer of the International Monetary Fund (IMF) undertook a comprehensive study, in 2008, on this area and the findings remain extremely relevant today. They find that enhancing equality in a country can lead to more sustainable economic growth. The key question here is: why does economic growth end more unexpectedly in some countries (with downturns being severe)? Attempting to get to the heart of the issue, the authors advise that we look at “turning points” in a country’s economic performance:
“If an economy has been falling off a cliff for a number of years and then turns itself around and starts climbing a mountain, it makes sense to ask what is going on around the time of the transition, and during the growth episode, to uncover any commonalities in the experience that can plausibly be exploited in other contexts. Likewise, if a country has been growing well for a number of years, but suddenly changes course for the worse, it would be useful to know what the path out of growth looks like so that other countries can take a different fork in the road”
The policy implications are significant. For example, trade liberalisation, often encouraged to boost economic growth, can also come with greater inequality, thereby affecting the country’s long-term economic performance. However, analysis shows that export focused policies - including export of manufactured goods, encouraging Foreign Direct Investment (FDI), and exchange rate stability and competitiveness - can reduce inequality. Exhibit 2 shows the effect of increase of different factors on economic growth spells. The key finding here is that a “10-percentile decrease in inequality - the sort of improvement that a number of countries have experienced during their spells - increases the expected length of a growth spell by 50 percent.”
Exhibit 2: Inequality and Growth Spells
These and other findings are gaining mainstream attention. Standard & Poor’s recent report notes the importance of addressing inequality in developing countries as igniting growth is less difficult than sustaining it”. Even Wall Street is taking note - with Morgan Stanley recently positing that inequality is hindering economic growth.
Economic growth is not always pro-poor. In a time of burgeoning consumer debt and increasing government austerity, policymakers need to place greater emphasis on “growth spells”, which incorporate both growth and inequality-reducing policies, to achieve sustainable long-term economic progress.