Income distribution under Latin America's new left regimes

This paper reviews factors that have led to a decline in income inequality that has taken place over 2002–2007 in most Latin American countries against the background of its steady increase over 1980–2002. The paper then analyses the factors that could explain this trend reversal. It focuses in particular on favorable external conditions, cyclical factors, improvements in the distribution of educational achievements and the subsequent drop in skill premium, and changes in macro-economic and social policies introduced in several countries, particularly by a growing number of left-of-centre governments that have come to power during the past decade.

It seeks to understand the extent to which high historical levels of inequality in the distribution of land, other forms of wealth, human capital and political power and other changes explain the decline in income inequality recorded since 2002 in most of the region; and whether these changes are permanent or they are likely to be overturned by the current crisis.

It discusses four groups of factors that explain the decline in income inequality over 2002-2007. These include:

• the favorable external environment of 2002–2007
• the rapid regional growth of GDP during this period
• the longer term improvements in human capital formation and in its distribution
• the changes in economic and social policies part of the ‘new Left-Of-Centre (LOC) Latin American model’ that has been gradually taking shape during the past decade.

Using regression analysis the report shows that among all the variables considered, those with the biggest impact on income inequality are (in descending order):

1. the drop in the Gini of educational achievements due to sustained investments in education that affected the skill premium
2. the choice of an appropriate Real Effective Exchange Rate (REER)
3. the labour market and social expenditure policies
4. ‘social democratic’ and ‘populist’ dummies that measure the effect on inequality of progressive policies and conditions other than those explicitly considered in the regression analysis. 

The terms of trade gains and the growth recovery also contributed to the decline in inequality over 2002–2007 but in a quantitatively less important way, while migrant remittances and portfolio flows were not significant, and the stock FDI/GDP had a lesser impact on inequality, although its parameter is highly significant.

This paper concludes that improvements in educational equality, favorable terms of trade, and pro-poor policies contributed to reduce income inequality. It recommends that current and future inequality trends will depend on the ability of governments to sustain the measures introduced during the recent past in the field of direct taxation, social expenditure, labour market policies and a gradual drive towards an integrated, universal social protection system.