Economic Growth

Christine Lagarde: How growth policy can reduce inequality

A man walks past buildings at the central business district of Singapore February 14, 2007. Singapore's trade-reliant economy expanded faster than expected in the fourth quarter on a pick up in domestic activity, data showed on Wednesday, prompting the government to lift its expectations for 2007.  REUTERS/Nicky Loh  (SINGAPORE) - RTR1MDL4

Economic growth does not always correlate with even distribution of wealth, says Christine Lagarde. Image: REUTERS/Nicky Loh

Christine Lagarde
President, European Central Bank
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Inclusive Growth Framework

Growth is essential for improving the lives of people in low-income countries, and it should benefit all parts of society.

Traveling through Africa in January, I have been amazed by the vitality I have witnessed: business startups investing in the future, new infrastructure under construction, and a growing middle class. Many Africans are now making a better living and fewer are suffering from poverty. My current host, Uganda, for example, has more than halved its absolute poverty rate to about 35 percent from close to 90 percent in 1990.

But we have also seen a flip side. Poverty, of course, but inequality as well remain stubbornly high in most developing countries, including in Africa, and too often success is not shared by all.

We have learned, both from working with our member countries, and from our research, that sharing the fruits of growth—what we call inclusion—is key to achieving sustainable economic growth. All segments of society should feel that they have an opportunity to make a better life for themselves.

Our new staff analysis, released today, uncovers the various channels through which critical reforms that promote growth (such as those in agriculture, the financial sector, and public investment) can sometimes widen inequality in lower-income countries. The study also illustrates how additional measures can mitigate such growth and equality trade-offs.

The bottom line is this: First, pro-growth policies can be truly inclusive only if policies are designed with careful attention to the details of who gains and who loses. Second, well-targeted measures can ensure that everyone gains from essential economic reforms—and help further strengthen the case for pursuing reforms.

A look at who gains and loses

Lifting growth and reducing inequality is especially hard in countries where workers cannot relocate easily and there are big productivity differences between services, industry, and agriculture. A large informal economy, poor infrastructure and lack of financial services make the task even more difficult. Yet, in many of the IMF’s poorest member countries, this is often the case.

In sub-Saharan Africa, for example, it is more than twice as expensive to move from rural to urban areas than it is in China. Only a third of sub-Saharan African households have electricity, compared to 85 percent in the rest of the world. And in low-income countries, only about 20 percent of the adult population has a bank account, compared to more than 80 percent in the rest of the world.

Such barriers get in the way of successful and equitable reforms. Infrastructure development and financial sector reforms are examples.

More, and more efficient, spending on roads, airports, power grids and education help an economy grow more productive and make it easier for people to relocate from farms to cities. But infrastructure investment can also increase inequality if some sectors of the economy become more competitive than others, particularly if labor mobility is limited.

 The return of the 20s
Image: Washington Center for Equitable Growth

The case is similar for financial sector reforms. On the positive side, these reforms could make it cheaper to borrow, thereby stimulating private investment and boosting growth. But unless financial reforms are deep enough, they may not help poorer segments of the population obtain access to credit and financial services.

How to deliver strong, but inclusive growth

So, what can be done? The answer is not for policymakers to hold off on reforms that boost productivity and growth. Rather, policymakers should consider options that make these reforms more palatable from both a growth and distributional perspective.

With this in mind, our staff paper looks at a number of country cases and analyzes how well-targeted measures can complement reforms and offset adverse distributional impact.

For instance, if Malawi were to consider reducing subsidies for maize production to enhance productivity in the agricultural sector, then targeted cash transfers to affected households would help provide immediate support to farmers who may be hurt by this move. This approach has been successful in reducing poverty and inequality in countries such as Ethiopia, which has one of the largest social transfer programs in Africa.

Similarly, with regard to financial sector reform, if Ethiopia were to increase credit to the private sector to promote manufacturing and boost growth and employment, complementing this by broadening financial access to the rural population and increasing labor mobility—through easier transport that connect rural and urban areas, affordable urban housing, and training—would help reduce inequality across sectors. Rural workers would then be able to find better paying jobs in more modern and competitive sectors, such as manufacturing and services.

Governments can also target investment to improve productivity in disadvantaged sectors, and even out the impact of other reforms. In Myanmar, for example, where half the workforce is on farms, investment in electrification, irrigation, and research and development for improved seed varieties could sharply improve agricultural productivity.

There is no doubt that governments will face challenges in building a consensus for bold policies to boost growth. The IMF will continue to work with them, advocating reforms that bear fruits for everybody to enjoy.

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