Growth still is good for the poor

David Dollar, Tatjana Kleineberg, Aart Kraay, 19 November 2013

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With the formulation of the Post-2015 Development Agenda in full swing, it is important to reassess how and to what extent new development challenges should be reflected in the agenda. A key part of the soon-expiring Millennium Development Goals aimed at halving absolute poverty – as defined by the World Bank's $1.25/day standard – between 1990 and 2015. This goal was reached in 2010 – five years ahead of schedule – when the global poverty headcount hit the 21% mark (United Nations 2013).

Twin goals of ending global poverty and promoting shared prosperity

However, these past successes are making the austere threshold of $1.25/day absolute poverty less relevant for many developing countries, as a smaller and smaller fraction of their population lives under this threshold. More differentiated measures are therefore necessary to effectively monitor and motivate further progress in living standard improvements.

This thinking led the World Bank to put a new institutional emphasis on tracking ‘shared prosperity’ – which is defined in terms of the growth rate of incomes in the bottom 40% of households – and to publicly commit to the twin goals of ending extreme poverty and fostering shared prosperity in the developing world (World Bank 2013).

This new emphasis on shared prosperity naturally raises two key questions:

  • First, to what extent does shared prosperity differs from simply prosperity, where the latter could be defined as overall aggregate income growth?
  • Second, are there macroeconomic policies and institutions that can directly support shared prosperity, other than through their effects on overall growth?

Our recent research addresses these two questions (Dollar et al. 2013), elaborating on earlier work done in Dollar and Kraay (2002).

Our core results show a strong equiproportionate relationship between overall growth and average income growth in the poorest quintiles, indicating that overall growth plays a major role in promoting shared prosperity. Concerning the role of macroeconomic policies, we find no robust evidence that particular policy combinations are especially conducive to promoting shared prosperity, other than through their direct effects on overall economic growth. This of course does not imply that there are no policy interventions that might promote a rising income share of the poorest quintiles. However, it does tell us that the historical record over the past four decades provides little guidance on the choice of particular macroeconomic policies that support shared prosperity, as distinct from aggregate economic growth.

Overall income growth explains most of the variation in income growth of the poor

We revisit the relationship between average income growth and income growth in the poorest quintiles using an unbalanced and irregularly-spaced panel of country-year observations on average income and its distribution, covering 118 countries during the past four decades. We decompose the income growth of the poorest quintiles into average income growth and increases in the share of income accruing to the poorest quintiles. This allows us to assess the roles of growth and changes in income distribution in driving shared prosperity.

Our results confirm a strong equiproportionate relationship between income growth in the poorest quintiles and overall income growth. In our core specification, which regresses average income growth in the poorest quintiles on average income growth, we find a slope coefficient very close to – and not significantly different from – one, indicating that incomes of the poor increase on average at the same rate as overall average incomes. Moreover, a standard variance decomposition indicates that three-quarters of the cross-country variation in income growth of the poorest 40% of the population is due to growth in average incomes. These results underscore the importance of overall growth for improvements in living standards among the poorest in society.

Policies promoting shared prosperity are difficult to identify

Although growth in average incomes accounts for most of income growth in the poorest quintiles, it is nevertheless important to investigate the role of macroeconomic policies in driving the remaining variation. If, for example, there are some policy combinations that increase the share of incomes accruing to the poor, while sustaining a given growth rate, these would naturally be preferred from a standpoint of promoting shared prosperity. However, if trade-offs existed in the sense that pro-poor policies might lead to lower average growth rates, policymakers would have to be aware that these effects can offset each other in the goal of promoting shared prosperity.

We therefore investigate how the income growth of the poor correlates with a variety of country-level variables commonly thought to matter for growth, such as trade openness, and macroeconomic and political stability. We also consider a number of variables which are considered by the broader literature to matter directly for inequality, such as primary school enrollments, inequality in educational attainment, government expenditure in education and health, and agricultural productivity.

Using Bayesian Model Averaging, we systematically analyse the correlation between the income growth of the poor and all possible combinations of the above-mentioned policy variables, holding average income growth constant. Overall, we find no systemic evidence that any of the policies and institutions reflected in these variables are significantly correlated with growth in incomes of the poor, beyond any direct effect of these variables on growth itself. The lack of a systemic correlation between these policy variables and the income growth of the poor does not imply that no policy combinations exist which can effectively support pro-poor growth. However, it is humbling that the historical experience in a large sample of countries does not provide much guidance on which combinations of macroeconomic policies and institutions might be particularly beneficial for promoting shared prosperity – as distinct from simply prosperity.

Growth is still good for the poor

Our findings suggest that growth still is good for the poor, in the sense that the incomes of the bottom 40% of the income distribution generally rise equiproportionally with mean incomes. Moreover, we find that three-quarters of the variation across countries and over time in growth in incomes of the poor can be explained by variation in average growth rates.

When attempting to correlate changes in inequality with policy variables that the empirical literature found to be important for economic growth or for distributional outcomes, we find that none of the macro variables we consider provides a systematic and robust relationship with the income growth of the poor, when also controlling for average income growth.

We therefore have good and bad news regarding the goal of promoting shared prosperity. The good news is that policies that promote economic growth will on average also raise incomes of the poor, thereby promoting shared prosperity. However, the bad news is that we cannot identify specific macroeconomic policies which are particularly conducive to promoting shared prosperity other than through their direct effects on economic growth. This underscores the challenge in defining practical actions and approaches to tackle the goal of promoting shared prosperity in the Post-2015 Development Agenda.

Disclaimer: The views expressed here are the authors and do not reflect those of the World Bank, its Executive Directors, or the countries they represent.

References

Dollar, David and Aart Kraay (2002), “Growth is Good for the Poor”, Journal of Economic Growth 7: 195–225.

Dollar, David, Tatjana Kleineberg, and Aart Kraay (2013), “Growth Still is Good for the Poor”, World Bank Policy Research Working Paper 6568.
Luxembourg Income Study Database (2013), May. http://www.lisdatacenter.org

PovcalNet Database (2013), the online tool for poverty measurement developed by the Development Research Group of the World Bank, May. http://iresearch.worldbank.org/PovcalNet/index.htm

United Nations (2013), “Millennium Development Goals Fact Sheet 1: Eradicate extreme poverty and hunger”, September.

World Bank (2013), “The World Bank Goals: End Extreme Poverty and Promote Shared Prosperity”.

Topics: Development
Tags: development, growth, Inequality, Millennium Development Goals, Poverty, World Bank

Senior Fellow in the John L. Thornton China Center, Brookings Institution
PhD Candidate in Economics, Yale University
Economist in the Development Research Group, World Bank