Lessons from Latin America: Antipoverty Efforts Can Promote Growth

Latin America's successful foray into social democracy should be a reminder that social justice need not be ignored in the name of economic efficiency

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Robert Hahn is director of economics at Oxford's Smith School, chief economist at the Legatum Institute, and a senior fellow at the Georgetown Center for Business and Public Policy. Peter Passell is a senior fellow at the Milken Institute in Santa Monica and economics adviser to the Legatum Institute. They co-founded Regulation2point0.org, a web portal on economic regulation.

Everybody enjoys a feel-good story. And for economists, anyway, the latest data on income inequality in Latin America fits that description very well. After decades in which the income divide in this most divided of regions only seemed to grow wider, the process has abruptly reversed. What's more, the reasons for the reversal, as explained by Giovanni Cornia of the University of Florence and the United Nations University, suggest that governments in other rapidly developing regions aren't quite as powerless to lean against the global winds of inequality as the conventional wisdom suggests.

Bitter inequality in Latin America—the legacy of Spanish colonialism, dependence on commodity exports, and bad government from both the left and right—has long been the shame of the region. Brazil, for example, has been dogged by poverty and extremes of income rivaling that of South Africa, the world's worst offender on this score.  Moreover, following the advice Latin America got from international development agencies—the mix of fiscal/monetary prudence, deregulation of markets, and open capital markets known as the Washington Consensus—only seemed to make inequality worse during the 1980s and 1990s.

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The standard explanation is that income distribution in Latin America started in a very bad place during colonial rule. And what began as ruthless exploitation by Europeans and then locked in by the elites that succeeded them, has been sustained—even exacerbated—in recent decades by the forces of globalization. But to just about everybody's surprise, the trend reversed sharply after 2001.

In part, the improvement is simply a product of the dates that bracket the measurement period. Latin America was recovering from the global recession in 2001, and the resulting rise in employment helped to trim back poverty. But only in part: Cornia estimates that just one third of the change can be linked to the reduction in unemployment. And tellingly, the far deeper global recession of 2008-9 did not erode the ground gained after 2001.

So what could account for the good news? In a nutshell: more competent democratic government, combined with a mild tilt toward antipoverty policies favored by the center-left.

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First, the competence part. Many Latin governments used the windfall from taxes on commodity exports in the last decade to stabilize their economies, balancing their budgets and keeping inflation under control. This is a very big change from the bad old days, when politicians spent lavishly on their favored constituents during the boom years (often exacerbating inflation) and then had no cash on hand to get through recessions. Chile has even made this countercyclical budgeting process automatic, legally requiring the government to sequester revenues from copper sales in the good years. Changes in policies toward the poor, though, have also made a big difference. Latin America lurched to the left in the last decade, most visibly in the radical-populist regimes of Hugo Chavez in Venezuela and Evo Morales in Bolivia. But during these years, center-left governments in Brazil, Chile, and Argentina pursued modest redistributive polices aimed increasing living standards for the very poor. Cornia estimates that spending on antipoverty programs explains one fifth of the reduction in inequality, while increases in the minimum wage (buttressed by increased investments in primary and secondary education) explain another fifth.

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Is there a lesson here for developing countries in which income redistribution measures are widely viewed as antithetical to growth? No and yes.

One ironic reason that modest changes in policy had a significant effect in Latin America is that inequality is so pronounced. In Brazil, for example, small cash incentives offered to very poor families to send children to school significantly increased their living standard. China, for its part, must also cope with a divide between rural and urban consumption. However, nothing like that faced by Brazil because the great majority of Chinese villages already have adequate primary education and clean drinking water. And the sums needed to make a material dent in China's rural poverty—say, by building housing or bringing medical care up to urban standards—would be quite large.

But Latin America's largely successful foray into social democracy should be a reminder that developing economies need not ignore social justice in the name of economic efficiency—that, if carefully targeted, spending on the poor need not bust budgets or undermine incentives for growth. Hey, there might even be a lesson here for rich countries that can no longer "afford" compassion.

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