The Recent Fall in Inequality in LAC: Searching for an Explanation

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1 The Recent Fall in Inequality in LAC: Searching for an Explanation A. de la Torre, D. Lederman, and J. Silva Office of the Chief Economist Latin American & the Caribbean The World Bank Group Madrid, June 2015

2 Stylized facts 2

3 The recent fall of income inequality in LAC is a break with its history and was rather unique by int l comparison Household Income Inequality Across Regions Sources: Luxemburg Income Study, SEDLAC, PovCalNet. 3

4 It was widespread across LAC countries (the result stands even if the income of top earners is included) Change in Gini coefficient: Sources: Lusting and Ferreira (2015), based on SEDLAC (CEDLAS and The World Bank) for LAC, for Latin American countries; WDI (World Bank) for Indonesia, Russia and South Africa; and Income Distribution Database (OECD) for United States. 4

5 More than by redistributive policies, it was driven by a fall in inequality within labor income (labor shares fell) Decomposition of the Evolution of Household Income Inequality circa Source: Cord, L., O. Barriga, L. Lucchetti, C. Rodriguez-Castelan, L. Sousa, D. Valderrama (2014) Inequality Stagnation in Latin America in the Aftermath of the Global Financial Crisis. World Bank Unpublished Document. 5

6 Faster wage growth at the bottom was common across the region, but more pronounced among commodity exporters Smoothed changes in real hourly wages by skill percentile, (Occupations are ranked according to their skill level in the base period) Source: Authors elaboration. The surveys used were Brazil (PNAD), Chile (CASEN), Ecuador (ENEMDU), Bolivia (ECH), El Salvador (EPHM), Mexico (EIGH) and Costa Rica (ENAHO) 6

7 Why did labor income inequality fall? The decline in skill/education premium is a prime suspect Labor and Total Income Gini and the Tertiary to Primary Education Wage Premium (LAC Average)

8 Why did the skill premium decrease? From supply to demand factors 8

9 H1: Rise in the quantity supplied (more educated workers)? A common factor but rise did not accelerate in the 2000s LAC: Relative Supply of Skilled (More Educated) to Unskilled (Less Educated) Labor The percentage of the labor force with tertiary education actually rose less during the 2000s compared to the 1990s Sources: Authors elaboration. 9

10 H2: Decline in the quality of supply (lower quality of tertiary education among new entrants to the labor force)? Case Study Colombia Average test score before entering tertiary education Distribution of new entrants to tertiary education into new and existing programs Did returns to tertiary education fall because of less prepared students at entry or because of a degraded quality of tertiary education ( garage universities )? Source: Camacho, A; Messina, J and Uribe, J.P. (2014) Heterogeneous returns to higher education: Bad programs or bad students? World Bank unpublished paper. 10

11 In Colombia, controlling for student characteristics and area of study, the effect of garage universities is limited (1) (2) (3) (4) (5) (6) (7) (8) New program in new institution *** [ ] *** [ ] *** [ ] *** [ ] *** [ ] *** [ ] ** [ ] *** [ ] New programs in an existing institution *** [ ] *** [ ] *** [ ] *** [ ] *** [ ] *** [ ] *** [ ] *** [ ] Constant *** [ ] *** [0.4102] *** [0.4027] *** [0.3965] *** [0.3706] *** [0.3703] *** [0.3685] *** [0.4037] Year FE No Yes Yes Yes Yes Yes Yes Yes Age gender FE No Yes Yes Yes Yes Yes Yes Yes Test Score in HS No No Yes Yes Yes Yes Yes Yes School FE No No No Yes Yes Yes Yes Yes Area No No No No Yes Yes Yes Yes Level of education No No No No Yes Yes Yes Yes Institution No No No No No Yes Yes Yes characteristics Departamanent FE No No No No No No Yes Yes Familly Income& No No No No No No No Yes Parents education Observations Adjusted R Source: Camacho, A; Messina, J and Uribe, J.P. (2014) Heterogeneous returns to higher education: Bad programs or bad students? World Bank unpublished paper. 11

12 H3: Faster skill obsolescence due to changes in demand? Faster rise in years of education for younger worker cohorts Brazil: Mean years of education at age 30, by young and old cohorts, covers the period Argentina: Mean years of education at age 30, by young and old cohorts, covers period Source: Panel A: Campos-Vazquez, Lopez-Calva and Lusting, (2014), Declining wages for College-Educated Workers in Mexico: Degradated Tertiary Education or Skills Obsolescence?. Panel B: Authors calculations 12

13 but it was the wages of older (more experienced) educated workers that fell the most Mexico: Hourly Wage Growth by Cohort (For males with college education) Argentina: Hourly Wage Growth by Cohort (For males with college education) Source: Panel A: Campos-Vazquez, Lopez-Calva and Lusting, (2014), Declining wages for College-Educated Workers in Mexico: Degradated Tertiary Education or Skills Obsolescence?. Panel B: Authors calculations 13

14 H4: changes in relative demand for skilled vs. unskilled labor due to asymmetric terms of trade and China effects? LAC: PPP-Adjusted Wage Growth Across Sectors, by Country Groups Commodity Importers Commodity Exporters Source: Cord, Genoni & Rodríguez (2015) based on data from SEDLAC (CEDLAS and the World Bank).

15 Labor income equalized across country groupings but with very different sectorial wage dynamics LAC: Differences in Wage Growth Across Sectors, by Country Groups LAC: Sectorial Shares of Employment, by Country Groups LAC Commodity Exporting Countries LAC Commodity Importing Countries Commodity Importers Commodity Exporters Source: Own calculations based on Cord et al. (2015). Data from SEDLAC (CEDLAS and the World Bank).

16 H5: Rising heterogeneity across firms? Costa Rica: Decomposition of the Variance of Wages (Full time male workers) 16

17 Final remarks 17

18 More research is needed but we are not completely in the dark That the inequality reduction phenomenon was widespread across LAC countries clearly suggests that common factors were at work Why the decline in labor income inequality? The fall in the skill premium, proxied by a reduction in the returns to education, appears as a primary candidate But other factors were obviously at work, as other gaps also closed i.e., reductions in gender, ethnic, and rural-urban pay differentials (Ñopo, 2012) Why the decline in returns to education? Stories based on the quantity of education supplied fall short Stories based on demand-side factors cannot be dismissed Different macroeconomic and sectorial effects of the same commodity/china shock Accelerated skill obsolescence Rising heterogeneity across firms Will inequality rise with the end of the commodity/china super-cycle? Not necessarily but there may be role reversal 18

19 Thank you! 19

20 Extra Slides 20

21 Co-movement between returns to education and the labor income Gini is observed also on a country by country basis Tertiary to Primary Education Returns and Gini Coefficient of Labor Earnings Argentina Brazil Chile Skill Premium - Tertiary to Primary Labor Gini Skill Premium - Tertiary to Primary Labor Gini Labor Gini Tertiary to Primary Labor Gini Tertiary to Primary Labor Gini Tertiary to Primary Labor Gini Prediction with average age of cell Prediction with average age of cell Prediction with average age of cell Colombia Mexico Peru Skill Premium - Tertiary to Primary Labor Gini Skill Premium - Tertiary to Primary Labor Gini Labor Gini Tertiary to Primary Labor Gini Tertiary to Primary Labor Gini Tertiary to Primary Labor Gini Prediction with average age of cell Prediction with average age of cell Prediction with average age of cell 21

22 Other gaps beyond education were also closing Source: Ferreira, F; Firpo, S; and Messina, J (2014) A more level playing field? Explaining the decline in earnings inequality in Brazil, World Bank unpublished paper. 22

23 Macro drivers of inequality in the short-run Elasticities of the Gini Index It is the changes in employment, and not changes in growth per se, that matter most for inequality but changes in real wages, hence in the exchange rate and tradable prices, also affect inequality, but less forcibly hence, social equity objectives favor employment stability over real wage (exchange rate) stability Employment Ratio REER Food Price Index

24 Labor markets: is the worst yet to come? Wage deceleration and increasing unemployment Unemployment Rate Average Real Wage Growth in LAC, Source: WEO and ILO

25 Will inequality increase? Will there be a role reversal between labor markets and social transfers? Wage growth in LAC countries with and without commodity boom Russia: Contribution to observed inflow into middle class (in percentage) 100% Other income 80% Private transfers Other public transfers 60% Pensions Capital 40% Wage (public) Wage (private) 20% Employment rate Dependency (Old) Dependency (Young) 0% -20% Period of terms of trade improvement Period of terms of trade deterioration Source: World Bank staff calculations using data from SEDLAC (left panel) and from the RLSM-HSE, (right panel) 25

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