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Financial policies can make a difference on income inequality

A new report released by the United Nations paints an alarming picture of the inequality situation worldwide. The rise of inequality on the global agenda was in display no less than at the latest World Economic Forum, recently held in Davos, where it was considered the most serious global risk.

The UN’s Report on the World Social Situation offers a wealth of figures and statistics to back up the concerns. Taking the period of 1990 to 2012, it finds that in 65 out of 130 countries, inequality in disposable income increased. These countries are home to two thirds of world population. Citing research by Ortiz and Cummins, it finds that in countries where inequality rose, the income is increasingly concentrated at the top of the distribution ladder.

But the report’s most valuable contribution to establishing the link between financial policy and human rights is, perhaps, not in its reminder of the worrisome state of inequality in the world. It is in the finding that the right policy interventions can, and do, bring greater equality: “Successful cases of reducing inequalities illustrate the importance of policies and institutions in shaping inequality trends.” This finding is significant from a human rights perspective because human rights law provides for States to use all tools at their disposal to ensure the enjoyment of human rights for all. The existence of certain policy tools States can use to reduce inequality is what creates the basis to claim, in the face of a State’s omission to use them, that a breach of human rights obligations could have occurred. And the fact that some of those tools are policies of a financial nature represents a critical aspect of the link between financial policies and human rights.

Although some economists have made the case that inequality is an inevitable by-product of development, the study disputes such finding commenting that there is limited empirical evidence to support it, as countries at similar stages of development show very different levels of inequality.

The report argues that redistributive policies on social transfers and taxes are largely to account for the difference, although “the magnitude of their impact will depend on the degree of progressiveness of the tax system (income and property taxes are usually progressive, while indirect taxes are regressive) and on the degree to which the poor benefit from social transfers and social insurance.” It also highlights the importance of tax policies in citing evidence that “negative effects of indirect taxes on the incomes of the poor, or nearly-poor, can be stronger than the positive effects of cash transfers.” The International Monetary Fund Managing Director, Ms Christine Lagarde, recently coincided by recognizing the importance of making taxation more progressive (even though in the same presentation she called for “targeted social programs,” which the UN report considers of inferior effectiveness compared with universal provision programs).

Unfortunately, in several developed countries the growing tendency to back away from government intervention has meant that redistribution has decreased, says the document. According to it, between 1990 and 2007 the relative difference between the Gini coefficient –which measures inequality—of market income and that of disposable income –income after the government interventions – declined or remained constant in six out of 12 developed countries it examined for this purpose.

The study offers support to what can be called the “instrumental” case for reducing income inequality, namely, that inequality is bad for growth and development. It cites IMF economists Berg and Ostry who, in a study that examined the relationship between income inequality and economic growth across 174 countries, concluded that inequality was a strong determinant of the quality of growth.

Another channel by which the report argues inequality affects growth is by leading to greater market volatility and instability. “One of the important ways in which inequality has created economic instability is through its impact on the generation of finance-driven business cycles,” it states, mentioning that both the Great Depression and the Great Recession were preceded by sharp rises in income inequality.

When the report discusses the channels by which the recent global financial crisis worsened inequality, it also underscores the difference that financial policies can make. While the impacts were generally negative, it points out that countries in Latin America, several in Africa and a few in Asia experienced declines in income inequality between 2003 and 2010 and in those places “proactive public policies” were the ones playing critical role in ensuring that the crisis did not harm the population in the bottom half of the distribution disproportionately. According to the report this is evidence of the importance of, among others, fiscal policy in shaping the effects of growth on poverty reduction, social mobility and social cohesion.

The relationship between inequality and poverty reduction is also scrutinized. At a time when the feasibility of pursuing paths of growth are called into question by growing concern about the limited resources in the planet, the report recalls the refreshing fact that growth is absolutely necessary to reduce poverty only if there is no change in patterns of income distribution. In addition, growth will be less effective in reducing poverty in high-inequality countries, even when the distribution does not worsen. Low levels of initial inequality, or even modest reductions, can have relatively large poverty-reducing effects. It cites research showing that “growth accompanied by improved distribution worked better than either growth or distribution alone, and that provision of civil liberties and political rights enabled people to participate more actively in reducing poverty.”

The report focuses on fiscal and monetary policies, and claims they can affect inequality not only because they have a bearing on income distribution, but also through their role in resource mobilization for social investment. But “while in developed countries political economy changes may have led to the shift away from progressive to more regressive fiscal policies, in developing countries the problems may be somewhat different.” Among these it cites low levels of revenue collection, associated with a narrow tax base and lack of diversification. The role of international cooperation on tax matters is also addressed in referring to tax havens and capital flight.

The situation of countries where natural-resource extraction is important receives a special reference. The report argues that in these countries there is often significant scope for altering the distribution of the rents from such resources in favour of the public treasury, citing the recent changes in the royalty structures of oil revenues of Ecuador, Bolivia and Venezuela, for example, as instructive. This issue is prominently featured in a recent report by the African Progress Panel which holds that “Obtaining a fair share of natural resource wealth and allocating the proceeds equitably are two of the most pressing governance challenges in the extractive sector.”

But other financial policies are also important. The report explains that monetary policies (those on control of interest rates and the availability of credit), can affect levels and patterns of inequality. Indeed, although it has been a tenet of monetarism that Central Banks –the entities usually responsible for making such policies– should be independent, human rights advocates argue that Central Banks are an arm of the State and, thus, not exempt from human rights accountability as any other part of the State apparatus.

In a subsection on asset inequalities, the report discusses other implications of credit policies for inequality. Attempts at land reform should be combined with broader rural development strategies and complementary measures, such as access to credit for farmers, it says. Likewise, it finds that there is a substantial concentration of other, especially financial assets, both within most countries as well as internationally: “In both developed and developing countries, there is great potential for enhancing tax revenues through more progressive taxation, that is, for increasing taxes on top earners and corporations.” It, thus, calls for reducing the personal and corporate concentration of assets.

International human rights obligations are not only relevant to States acting individually, but also to States undertaking cooperative action. Issues of inequality among countries are certainly not absent in the report. A stark comparison the report has is enough to place the importance of this aspect front and center: low-income countries created just above one per cent of global income even though they contained 72 per cent of global population. In order to address international inequalities it calls for broadening the scope of the global partnership for development. Among the recommendations the report stresses the need for the international trade agenda to be harmonized with other multilateral agreements in social development so as to form a more coherent, integrated approach and reiterates calls for a more effective regulatory system for international financial markets.

Income inequality, for a long time an issue of concern for human rights advocates, was now front and center in last January’s State of the Union address by President Barack Obama and the above-mentioned recent speech by the head of the International Monetary Fund Ms. Christine Lagarde. In that occasion she spoke of inequality as an issue that, not surprisingly, “everyone from the Confederation of British Industry to Pope Francis is speaking out about.” It seems leaders are in agreement about the problem. Let us hope they will now begin to throw their weight behind the solutions.


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January 2017
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