INTERNATIONALBANK FOR WORLD BANK R E T C N O E N STRUCTION PM AND DEVELO November 2005 No. 82 A regular series of notes highlighting recent lessons emerging from the operational and analytical program of the World Bank`s Latin America and Caribbean Region GROWTH, INEQUALITY, AND SOCIAL EQUITY IN ARGENTINA Carlos G. Fernández Valdovinos Background Sustaining the current positive economic trend and The dramatic economic collapse in Argentina, culminat- ensuring that it will benefit the poorest is a matter of top ing in 2002, resulted in the deepest political and priority for the Argentinean government. In fact, one of economic crisis in generations. Few countries have the difficult tasks that the country faces today is to experienced such economically catastrophic events. implement policies needed to support the economic Over the four-year period from 1999 to 2002, gross recovery, assist employment creation, and enhance the domestic product living conditions of the population. A recent report (GDP) fell by over prepared by the World 20 percent. The hu- Bank reviews man costs of the Argentina's growth, precipitous decline poverty and income in economic activity inequality perfor- have been substan- mance1. Valuable tial. The urban policy lessons can be poverty rate shot up drawn from the to 57.5 percent in study. This note pre- October 2002, sents some of its key while income in- findings. equality, which had been rising steadily, Growth, Poverty peaked in the after- and Inequality math of the crisis. Performance in By 2003, Argentina A r g e n t i n a ' s Gordon The country's slow economy began to economic growth rebound strongly. Russell over the past ninety Sparked initially by years has been ex- increased exports and by a gradual expansion of tensively discussed by economic historians. Argentina consumption spending, a demand-led recovery was among the world's highest income countries in 1913. emerged. This recovery has had a positive impact on the Historical data shows that economic growth was clearly living standards of the population. Nevertheless, the disrupted in most countries due to the adverse shocks of economic and social advances were relative to their the Great War, the interwar economic strains, the Great very low starting point, and large segments of the Depression and World War II. Yet other countries with Argentine population continue to face great hardship. comparable living standards and growth records before 1 these events subsequently managed to con- tinue their growth trend. This was not the case for Argentina, where growth did not resume anywhere near previously observed rates, and the economic slowdown set in beginning around the time of World War I. Between 1950-2000, Argentina's per capita income diverged downward vis-ŕ-vis the in- dustrialized countries, while its per capita in- come converged downwards towards Latin America's (See Figure 1). Even among Latin American countries, Argentina stood out as a particularly slow growth country, and only in Venezuela and Bolivia were growth rates lower. As a result, Argentina, once an unques- tionably advanced nation , became relatively American standards) that it was in the early 1990s. poor. This is one of the great puzzles of the country's Not only has growth been slow in Argentina, but there economic history. Unfortunately, there are no totally also has been substantial volatility in economic perfor- convincing simple answers to the question of what mance. Business cycles are common in all economies, accounted for the languishing performance of Argentine but the Argentine case seems to be set apart. Its erratic growth. economy may have contributed to slower growth over time as suggested by recent empirical studies. In fact, The last several decades revealed another puzzle. Argentina possessed greater output volatility between Inequality has increased persistently, resulting in rising 1960-99 than any other Latin American country or any levels of poverty in the face of stagnant, albeit widely major region, reaching its peak during the chaotic decade fluctuating, average per capita output. Per capita GDP in of the 1980s. With greater stabilization and macroeco- 2004 was at about the same level as in 1974. Neverthe- nomic balance in the 1990s, Argentina's volatility was less, poverty was much higher in 2004, reflecting an reduced, but it still remained higher than in most other increasingly unequal distribution of income. Remarkably, countries. the rise in inequality, and poverty, was observed in periods of both growth and recession (See Figure 2). Causes of Slow Growth and Poverty Moreover, although Latin America has not been very Increases successful in reducing poverty and inequality, the recent record of most countries in the region was better than Why has economic growth been so low in the country? that of Argentina. As a result, Argentina today is not the One perspective explains it by a lack of productivity low poverty, and more equitable country (by Latin growth. Productivity growth has long been recognized as a driving force for sustained economic growth. In the case of Argentina, a large number of recent growth accounting studies have sought to measure total factor produc- tivity (TFP) growth since the 1940s. There is a certain commonality in the results of these analyses. First, average TFP growth is gen- erally seen to be low, hardly more than 0.5 percent per year. Second, TFP growth rates are quite erratic, reflecting Argentina's high volatility as noted above. Third, the average TPF growth estimates are typically negative for the chaotic 1980s, and most positive for the 1990s. Fourth, when attempts are made to incorporate human capital accumulation, the estimates of TFP growth decrease ap- preciably. 2 The "informal empiricism" of economic historians high- it would be worthwhile to further explore this issue in lights other key developments to be considered in future research. understanding Argentina's poor growth performance - the closing of the economy in the 1930s, the reduced Recent Crisis and Recovery access to international capital markets that followed, inadequate investment incentives throughout much of the As indicated before, Argentina's volatility stands out post-war period, macroeconomic instability, the in- when compared to other countries. According to empiri- creased burden of the state after the 1930s, and weaker cal studies, high volatility in macroeconomic perfor- property rights. The negative impact of these develop- mance usually contributes to increases in the level of ments was validated by international experience and inequality and poverty. A review of the last economic recent cross-country econometric studies. Overall, im- cycle in Argentina offers an eloquent glimpse on the link proving macroeconomic stability, facilitating private sec- of volatility to poverty. After three years of continuing tor investment, strengthening the legal and institutional recession, the economic and financial situation of the framework, having a well-functioning system for finan- country worsened during 2001. Various attempts to spur cial mediation, promoting trade expansion and greater growth and improve public finances failed, and a crisis openness of goods markets, and extending human capital formation appear to be crucial actions for achieving sustained high rates of economic growth in Argentina. The country also has experienced rising poverty over time. However, the most striking fact is that poverty increased even in periods of economic expansion. The fact that poverty sometimes rose when growth was taking place is exceptional in international experience. As suggested before, low growth does not tell the whole story; increased poverty also was linked to a more unequal distribution of income. The question Giudice then arises as to why income became more unequal. Recent research has uncovered a number of factors Diego that explain the change in income inequality. Key factors include: (i) an increase in the relative returns to unfold. The social situation in the country, which was not higher education; (ii) a rise in the returns to unobservable good, significantly deteriorated after GDP declined by factors, such as the quality of education, family back- 10.8 percent in 2002. ground, individual ability and labor market connections, and the relative decline in hours of work for unskilled Poverty and extreme poverty rates rapidly increased workers; (iii) an increase in unemployment during the during the crisis. The official poverty rate showed that 1990s and changes in labor force participation from 1996 some 53 percent of the population was poor in May 2002, onwards; and (iv) increased integration into the global up from nearly 36 percent a year earlier.Additionally, the economy that encouraged production and employment in indigence rate rose from 11.6 percent to 24.8 percent the sectors using natural resources, helped reduce the during the same period. The economy rebounded quite relative price of capital, and introduced new "skilled strongly in 2003. Nevertheless, during the early stages of labor" intensive technologies. the recovery, poverty and indigence rates continued to increase, albeit only slightly.3 The economy continued to The high degree of income inequality is a factor that show strong performance by 2004, growing 9 percent. could have impaired growth. There is substantial theo- Importantly, economic recovery finally began to have a retical and empirical literature that identifies channels positive impact on living standards during that year, with through which income inequality negatively affects poverty and indigence rates finally falling. economic growth. As stated in one such study, "There is no evidence in the data that increases in inequality are As expected, economic activity during the cycle was good for growth. In fact, the bulk of the evidence goes in closely, and inversely, linked to income changes of the the opposite direction."2 However, further tests are poor. Even when adjusted by government transfers, the needed before an unquestionable conclusion can be income of the poor showed a positive correlation with reached. Given the rising trend in inequality inArgentina, the growth rate of the economy. Moreover, data indi- 3 cated that the poor benefited relatively more from the Since labor income is more important among the poor as a recent recovery - incomes of the poor grew faster than share of total income, and since the poor tend to be less- the average income of the entire population during the skilled, it follows that the pro-poor growth pattern upturn. That is, the recent phase of economic recovery observed during the recovery may have been linked to the in Argentina has been a pro-poor growth process, not sectoral composition of the recovery. In fact, those labor- only in the absolute sense, but also in relative terms. absorbing sectors that grew the most during the recovery also accounted for most of the changes in poverty during Why has recent growth been pro-poor? One possible the period. That is, the higher the economic growth of the explanation is that, as a result of changes in relative sector (weighted by employment share of the sector), the input prices, changes in sector growth patterns have higher was its contribution to poverty reduction. helped increase the positive effects of growth on the poor. The reason is that changes in relative input prices Conclusions probably led to changing patterns of inputs, and conse- quently shifts in the contributions of each economic The Argentine government has adopted a strategy that sector to growth in aggregate production. A brief emphasizes rebuilding the economy with a view to delivering sustained growth with social inclusion - an appropriate goal in view of the high degree of poverty and inequality in the country. It is important to recognize that growth is not only essential, but that it is needed over sufficiently long periods and with sufficiently pro-poor impact so that all segments of the population can expect a notable improvement in their lives and their livelihoods. The first part of the recovery after the deep crisis in 2001 has been successful in delivering strong growth with positive effects on the living standards of the population, especially the poor. Nevertheless, the persistence of Marcarian sound macroeconomic policies in the future, as well as the implementation of other key policies, will be crucial to Enrique observe high growth rates and further reductions in comparison illustrates the point. During the 1990s, poverty and inequality. interest rates decreased relative to wages, and the most dynamic sectors tended to be capital-intensive. In Notes contrast, real currency depreciation after the crisis 1See Report No. 32553-AR "Argentina: Seeking Sus- substantially reduced the cost of labor in the country. As tained Growth and Social Equity." The study also dis- a consequence, labor-intensive sectors became more cusses selected key policies that could help improve competitive after the currency depreciation. growth rates, while decreasing poverty and income inequality. An overall review of the sectoral growth pattern during 2See Banerjee, A., and E. Duflo (2003). "Inequality and the recent recovery period reveals that: Growth: What Can the Data Say?" Journal of Eco- sectors that contributed most to aggregate GDP nomic Growth, 8: 267-299. growth were different from those that explained 3For example, the percentage of poor individuals in- growth in the 1990s. The recovery shows the creased from 53.0 percent to 54.7 percent between May relatively higher importance of the contribution of 2002 and May 2003. Note that poverty rates peaked in the goods-producing sectors, mainly manufactur- October 2002, reaching 57.5 percent of individuals. ing, while in the 1990s, the services sectors were most important; the dynamic sectors during the recovery have been relatively more labor-absorbing; About the Authors the most dynamic sectors during the recovery demanded relatively more low-skilled workers Carlos Fernández Valdovinos is a Senior Economist in the compared to the sectors that led growth in the Poverty Reduction and Economic Management Unit in 1990s. the Latin America and Caribbean region of the World Bank. 4