Economic growth and 'something else' to address inequality

Although the developing world has achieved unprecedented economic growth rates over the past decade that have translated into a rapid decline in poverty, that growth has also come with rising inequality.

Inequality threatens social cohesion, limits social mobility and individual choice and reinforces factors such as inherited poverty or discrimination by gender, ethnicity and location, delegates heard last week at the 2nd OECD Development Center high-level meeting — part of Development Week 2014 hosted by the Organization for Economic Cooperation and Development.

So how can fast-growing developing economies close the inequality gap and ensure that economic growth is followed by structural transformation that not only reduces poverty but also improves access to opportunities, promotes mobility and enhances social capital?

They need to find ways to provide growth and “something else” or opportunities for social cohesion and mobility for those at the bottom of the pyramid, Julie T. Katzman, executive vice president and COO at the Inter-American Development Bank said during an interview with Devex on the sidelines of the event in Paris.

Below are more highlights from our conversation:

Social cohesion for growth is being talked about as one of the main challenges for growing economies — particularly fast-growing economies. How can they close the inequality gap and are there any concrete, practical solutions that are gaining traction this week here in Paris?

Whether yesterday or today, there is general agreement across the board that without social inclusion you have anything from lower growth to less durable growth … although I think the majority would say it's both less growth and less durable growth … You can see that in Latin America, for example, has been very successful in a macro sense, but that social cohesion and solving the problems of social inclusion have been elusive.

And you can see that in a lot of different ways. If you're an economist, you can see it by looking at the Gini coefficient. If you're the rest of us, you can see it by turning on the TV and watching people demonstrating, whether in Chile, Brazil, Colombia, or the countries of the Arab Spring. In Chile, because of the lack of quality in education; in Brazil, ostensibly because of the price of public transportation, but in reality about education and healthcare quality; in Colombia, because of the effects of poor infrastructure on farmers trying to get goods to market. You go around the world and that’s what you're seeing.

It’s a good news-bad news story about the gains of the last 10 years. There are fewer people in poverty and more people in the middle classes. With that, people’s demands and expectations are now higher and their willingness to go out and try to do something about them are also now higher. So that's the backdrop to that part of the conversation this week.

So it's raising the bar, but presumably you wouldn't be advocating for the management of expectations?

No, not at all. It's raising the bar in terms of expectations and raising the bar in terms of the downside if you don't meet the expectations. The fact that in Peru, for example, they’ve created a ministry of social exclusion, and in Colombia they’ve created a department of social prosperity tells you that governments have flipped the switch and said, “This is really important, both as a matter of economics, and as a matter of morals.”

A moral imperative?

Absolutely. Countries have used conditional cash transfers to create that first wave of movement up the ladder. But I think that we've seen that CCTs are not going to get you all the way there to a workforce that is capable of participating in 21st-century industry … It's not going to drive innovation.

So what do you do? If you look at the Mexican reform package, for example, you see a lot of pieces in there that directly or indirectly address this. And it ties with what we’re thinking about at IDB, namely what to do when the commodity boom has tapered and governments are going to have to figure how to do at least the same, if not more, with the same, if not less.

So what are some of the things that you are going to say?

Well, collect more taxes, but do it equitably. If you look at the Mexican tax reform, the top 20 percent are going to pay 60 percent of the increase in revenue. The bottom 40 percent are going to pay 13 percent. So that's important. If you're going to reform taxes, you've got to really be targeted — which takes political will.

And what happens in that tax reform?

You eliminate exemptions and you reduce or eliminate subsidies. After all, there are those with vested interests who would like to keep them. Their reform does something else too though: It puts in place electronic invoicing, for some 4.2 million micro- and small enterprises. So every two months, they will be reporting revenue and expenses. This is a way for these micro- and small enterprises to now start joining the formal economy, which is a big part of inclusion.

Do you see this as an example that can be rolled out in other countries in the region?

I do, I absolutely do. I think electronic invoicing in Latin America is at the forefront of it. That is clearly a technology that others can use and I think it is something that can help. Colombia has taken another approach, which is to decrease the taxes associated with formal employment from 30 percent to 16 percent. We have not yet completed an evaluation of the numbers, but they are reporting that formal employment has increased by about one million. It sounds really geeky to say that tax policy can be interesting, but it's genuinely a very potent tool if it’s done equitably.

The second thing you’ve got to do is spend better and avoid leakages … and spending better requires stronger institutions. Strengthening institutions is not an easy thing to do, so you have to look at how to be smarter about your institutional structures. There are countries that have four or five different CCT-type payments all housed in different institutions, so the likelihood that all of them can manage to get the targeting right is not high. Being smart about institutions while trying to strengthen institutions is important, and again, that means taking on bureaucratic vested interests.

Third, you've got to make sure that the institutions that allow for inclusion exist. A great example is financial inclusion. If you don't create both a framework and the incentives for your financial system to include the excluded — women, indigenous, Afro-descendants — then it won't happen. This also involves technology, because it’s technology that is going to be able to help by delivering cash transfers on a card ... And electronic money and payment systems are going to allow people who live in rural areas to participate in the financial system in a way they never could before.

Fourth, you have to deliver better quality services … because if you don't deliver better quality early-childhood education, technical training, basic services, and social protection, then you cannot change the culture of non-payment. So there's an interesting continuum that exists there.

And last but not least, encouraging the private sector to try to solve some of these previously intractable problems is an important theme.

It seems to me that there's often a symbiotic relationship between one sector and another — say health and education, for example. Was there any talk this week about joining up on some of these key sectors, or even among countries or regions?

Countries are beginning to think that about how certain interventions, certain targets of opportunity cannot be thought about in a silo. They are multi-sectoral problems that require multi-sectoral answers. Health and education have a number of those and there are lots of overlaps. Take, for example, teen pregnancy — it's both sectors. If you don't work across the sectors you're not going to solve the problem …

Is the private sector’s role to be seen predominantly as that of mobilizing finance or mobilizing expertise?

It's a combination of the two. I think it's accessing impact investment money and it's supporting social entrepreneurs and social entrepreneurship models. We need to look at community-based models and innovations to try to get to solutions. Everybody talks about digital natives, but in our region, the youth are both digital natives and democracy natives. And they are the first generation of democracy natives in many countries. The Internet is in effect their hardware and democracy is their software. And if governments don't solve the inclusion problem, they'll use the hardware and software to change governments, because their expectations are higher and they look around the world and know it can be achieved. Governments are going to be held to a much higher standard by people in the emerging markets. And they have the tools to be heard.

So to continue the software analogy, are we looking at a development 2.0? Are some of the things that we’re talking about now — in terms of social cohesion, in terms of access to finance, in terms of bringing small and medium-size enterprises into the fiscal arena — going to have as big an impact as many would hope?

I believe that access to finance isn't sufficient, but access to finance is really important. It isn't about just credit. It's about savings, it's about insurance, it's about payments. And when it's about credit, it's about credit at a reasonable rate, with a reasonable maturity to match what you're trying to do. If you don't have all of those things, then the likelihood of being able to build a business that is anything more than a subsistence-level business is pretty small. And if you're going to build a society where more people rise into the middle class and can then afford to send their children to university, that's a really important part of the overall economic system. Finding ways to include those companies into the formal economy so that they can access finance — and the whole suite of financial services — in an affordable and fair way is an important part of that. So I do think that it will move the needle.

A lot of actors have been talking for many years now about inclusive this or inclusive that. You’ve been discussing this week what is meant by inclusive growth. So what does it mean and how do we measure it in concrete terms?

I guess it depends on your definition of concrete. If you look at many of the world's leaders today, whether it's Barack Obama, Angela Merkel or David Cameron, when they talk about growth now they talk about growth and something else. Growth and education, growth and training, growth and…

Jobs?

Jobs, right. And I think what all of them are actually saying is growth and opportunity. When you listen to various people talk about inclusion or cohesion, it seems that this is the word around which people are pulled together ... How can that be concretely measured? Well if you then say that opportunity is about education, about financial inclusion, you have to break down how you express opportunity and whether or not those things are then measurable. And I think a lot of those things are measurable. Financial inclusion for those at the bottom of the pyramid is clearly measurable. It starts with disaggregating data and most countries don't. That's what you’ve got to start with.

Another interesting point from discussions this week was whether fiscal policy can be an effective instrument to address things like income and inequality. I wondered what your take was on that?

Well, yes, if you raise more equitably and you spend better then that's fiscal policy at work. In the OECD countries, the decrease in inequality as a result of taxes paid and then redistributed is to decrease inequality by 17 percent. In Latin America that figure is somewhere between 0 and 3 percent.

In other words fast growth doesn't automatically translate into upward social mobility?

No. And it doesn't automatically translate into being able to use fiscal tools. Because if you don't collect much in the way of taxes because of the way your tax regime is structured, and/or what you do collect you don't spend well, then you don't have a very effective tool. If, on the other hand, you do collect a reasonable amount and you spend it well, you target it well, and you have institutions that are capable of delivering and then you deliver the services that you're paying for well, then it can be an effective tool, no question.

What will you take back from these discussions to the membership at IDB?

In a world that is filled with digital natives and democratic natives, you have to be focused on inclusion. Because if you're not, political stability will suffer. It’s not mind-bending, but it requires really solid political will to deliver and that takes courage and it takes having a legislative body that's speaking the same language and it takes time to come into effect. So, it's not easy, but it's doable.

Do you think then that social cohesion and social mobility and equality in socio-economic development is something that can act as a hook or pivot for other future policies?

That's an interesting way to put it … I think that, at least in our region, people have previously pivoted around productivity. And if you're an economist, that makes sense. If you're an individual, I don't know if that makes sense. Maybe if you cast it in the context of inclusion, that's a better pivot point.

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