Focus on equity can hurt growth

In my October 2005 column, I questioned the central thesis of the World Development Report (WDR) 2006 that the policies aimed at achieving equity over and above those targeting poverty will lead to greater poverty reduction. I argued that putting equity at the centre stage of policy making in this manner is likely to undermine sustained growth and hence poverty alleviation.

In their reply (Dec 23, 2005), WDR authors Francisco Ferreira and Michael Walton question my critique. Among other things, they point out that whereas the WDR 2006 is concerned with equality of opportunity, my critique focused on equality of income. To quote them, “The World Development Report defines equity in terms of equality of opportunities, rather than of incomes, and the difference is not purely semantic.”

This is puzzling since the bulk of my critique focused on policies that impact opportunities directly, not just through income. To sort out the confusion that runs through the response by Ferreira and Walton as also the WDR, it is best to begin with a clear conceptual framework and the precise statement of the policy question at hand.

There is agreement that the ultimate objective of the policy is to improve the living standards of the poor. This can be accomplished by pro-growth policies that raise the incomes of the poor principally by pulling them up into gainful employment; tax and expenditure policies that redistribute, rather than create, income and purchasing power towards the poor; and policies that do not require resources but simply improve the ability of the poor to profit from the economy and its growth, a prime example being affirmative action in education.

The three sets of policies do not operate independently of one another. For instance, the last set of policies may have an adverse impact on growth. As such, though their direct impact may be to reduce poverty, their indirect impact (through adverse effect on growth) is to raise it.

It is fair to say that, except for a few who have never reconciled themselves to the facts, there is now broad agreement that policies that generate sustained rapid growth, which in turn offers the poor rapidly rising opportunities to earn higher incomes, have to be the primary instrument of poverty reduction.

Disagreements relate primarily to the second and third sets of policies. Though Ferreira and Walton seem to downplay the second set of policies when they (erroneously) criticise me for defining equity in terms of equality of income, the WDR clearly endorses them.

Early childhood development, expansion of education and improved healthcare facilities discussed in chapter VII and equity in the distribution of land discussed in chapter VIII are all about redistribution.

But then these types of redistributive policies have been the staple of development discussion for a long time and the WDR 2006 adds little to what is known.

They were also a significant part of the WDR 2000, which focused on poverty rather than equity. But even here, though chapters II-V offer detailed discussion of income inequality (rather than poverty) at the national and global levels, (including the indicators of income distribution such as the market capitalisation controlled by the top 10 families in many countries) income and expenditure Gini coefficients in various countries and between-group inequality in Figures 2.8-2.10 respectively, the WDR 2006 is virtually silent on how the redistributive policies aimed at redirecting opportunities towards the poor affect growth and therefore the first channel of poverty reduction.

What about the third set of policies? Great caution is necessary here: they can have a large negative impact on growth and hence poverty alleviation.

This was clearly ’s experience that I discussed in detail in my original critique. The reservation of labour-intensive products for small-scale enterprises, exclusion of large enterprises from many large-scale manufacturing activities and the nationalisation of banks were all motivated by a desire to redirect the opportunities from the rich towards the poor. But they greatly compromised efficiency and growth.

While the WDR does list policies that it claims will improve opportunities for the poor without compromising efficiency and growth, it greatly underestimates the ability of the lobbies to capture the policies once equity and “fairness” become central to policy making. Recently, some of the reforms in have become hostage to precisely this capture.

To counter the exclusionary attitudes and correct the past discrimination, the Indian Constitution mandated reservation of a fixed proportions of the slots in public educational institutions and public sector jobs for the scheduled castes and tribes.

The payoff to this policy in terms of increased opportunity for the poor has been limited: the castes and tribes within the reserved categories that happened to have better opportunities to begin with managed to capture the lion’s share of the reserved slots.

Moreover, in due course, other caste groups with lesser claims to discrimination but greater political clout also sought and got reservation. At the same time, the proliferation of reservation has had a detrimental impact on the economic reforms and hence growth potential. Today, privatisation of public-sector enterprises has been partially stalled because there is no provision for caste-based reservation in the private sector.

Rather than privatise, the government has chosen to partially disinvest, which leaves the enterprises in the public sector and preserves the reservation. Likewise, the entry of private universities in has been an anathema partially because the reservation policy could not be applied to private educational institutions unaided by the government.

The critical shortcoming of the WDR 2006 is that it fails to see how focus on the “equity-related” second and third set of policies can compromise the important first set of growth-promoting policies and actually hurt the assault on poverty. The Indian experience testifies to the importance of this factor.

Arvind Panagariya Times News Network, Wednesday, February 22, 2006.