Growth with Equity: The Challenge of Income Distribution

ETHOS Issue 02, Apr 2007

The rapid pace of globalisation, technology advances and economic restructuring over the last decade or so appear to have contributed to increasing income inequality and low wage stagnation and even decline in developed economies. In small and open economies such as Singapore’s, this phenomenon may be felt even more keenly, weakening of the social consensus that has existed so far in favour of free markets and competition. What should the Government do to address this challenge?

The uneven nature of income distribution in human society has existed for centuries. Income distribution was one of the earliest and most well-known examples of non-normal distributions that followed a power law. This statistical description was first recorded by 1896 by Vilfredo Pareto, the Italian economist who observed that 80% of all wealth resided with only 20% of the population—a phenomenon that eventually came to be known as the Pareto distribution—one of many kinds of power law distributions. In the 1980s, this also developed into an equally famous management dictum known as the Pareto principle, or 80–20 rule.

Yet although income inequality is not a new phenomenon in history, the urge for societies to seek a more equitable distribution has been hard to resist. For example, we communicate income data through statistics such as per capita Gross Domestic Product (GDP), or average and median household income to suggest that economic growth has raised incomes across-the-board. Indeed, the success of Singapore since independence has essentially been a story of “growth with equity”, a story of how it managed to achieve economic growth while ensuring that the fruits of that growth are distributed to large segments of the population.

THE SITUATION FOR SINGAPORE

According to the Department of Statistics, the Gini Coefficient has been creeping up over the years (indicating more unequal income distribution), even when adjusted for retiree households, from 0.442 in 2000 to 0.472 in 2006.¹ Gross monthly income for the lowest 20% has also experienced much slower growth since 1997. There has also been negative growth in the household incomes of the lowest decile since 1997. From around 2000 onwards, increase in incomes for the 50th percentile and below also slowed substantially in nominal terms. Factoring in inflation, real income growth was negative for the bottom two deciles. Given the various exogenous shocks to the economy during this relatively recent period, the jury is still out as to whether this stagnation in the incomes of the middle is a long-term, and not just a cyclical, trend. However, these trends do indicate a widening income disparity and income stagnation, particularly in the middle-income segments since 2001. This is a trend felt by developed countries across the world, which are experiencing an accentuation of income inequality. The US recently reported that although productivity growth had increased substantially between 2000 and 2005, increases in the median wage have not kept pace.² Globalisation, and the structural changes it has wrought on economies, has been commonly identified as the main culprit. In essence, workers are working harder and smarter, but ending up with smaller shares of the growing economic pie.

WHAT IS TO BE DONE?

There are two main instruments that the Government could consider to address the issues of widening income disparities and low and median wage stagnation: redistributive measures and human capital development measures.

Redistributive Measures

Redistributive policies aim to transfer part of income gains enjoyed by higher-income earners and the owners of capital to the lower-income segments of the population hurt by global trade. However, if the wages of half the population are stagnant, simply enhancing existing redistributive measures may not be sufficient. Here, the Nordic model offers some insights on how taxation and social spending systems can be both pro-growth and socially equitable.

The tax systems in the Nordic countries are far less redistributive and progressive than one would expect: capital is taxed lightly (compared with other industrialised countries), while consumption and labour bear the bulk of the tax burden. This conforms to economic theory: taxes that lean on consumption (which is less elastic) are less economically distorting that those which lean on capital, which is more mobile and hence more elastic in supply.

While the high labour taxes in the Nordic countries might discourage employment, one must also look at the other side of the tax-and-spend ledger. Nordic countries such as Sweden and Denmark spend up to a third of GDP on social transfers, not only in areas such as pensions and unemployment compensation, but also in areas that might yield high returns, such as child care subsidies. The social protection that the Nordic states provide to large segments of their populations also helps to build public acceptance for a not-so-equitable tax system.³

The Singapore Government has also tried to redistribute in a pro-growth way. The Workfare Bonus Scheme, introduced as a one-time transfer in 2006, targeted the lowest 20% of income earners. Recipients had to have worked for at least six months to be eligible for the bonus. This helped to encourage a work-for- reward ethic rather than one seeking handouts. However, a one-time transfer does not alter the income distribution and keep the lower segment of incomes up on a permanent basis, and the scheme was expanded in 2007 to become a permanent support programme known as the Workfare Income Supplement, which operates very much like the Earned Income Tax Credit in the US or the Working Tax Credit in the UK.

The overriding consideration for the Singapore Government in implementing any new redistributive measure is to ensure that it does not undermine economic growth, erode the work ethic, or distort incentives. In this regard, the Government could consider measures to moderate the effects of job volatility through some form of unemployment insurance. As more segments of the working population become vulnerable to downward income volatility for extended periods, a basic unemployment insurance scheme might be a more efficient way of providing them some form of income security. Unemployment insurance helps workers pool their risks to fund key necessary expenditures when faced with a sudden loss of income. A publicly administered unemployment insurance system, integrated with assistance in job placement, re-training and targeted welfare, could also help the recovery of household incomes after recessions. If so, social insurance against the risk of unemployment could be an important component of Singapore’s social safety net in the future.

Human Capital Development

If the Government wishes to avoid large social transfers of the Nordic variety, its main alternative would be to invest substantially more in human capital development. This can be done in a variety of ways.

One would be to provide subsidies to the lower-income households for expenditures beyond mere subsistence, so as to allow for human capital formation. Currently, low income households spend about 60% of their income on food, housing and utility bills, leaving them with little for investments in education and education-related areas. Some studies in the US have shown that children from lower income families develop persistent skills gap as early as the age of three compared to those from higher-income families, should they go without effective pre-school programmes.⁴ Perhaps a suitable starting point to address poverty issues in a sustainable way would be to provide for assistance in the form of enhanced subsidies in early childhood education.

Simultaneously, the Government could expand existing retraining and re-skilling programmes to help workers transit from declining sectors of the economy to the new, faster-growing ones. This could be an important instrument to address the possible stagnation of median wages.

CONCLUSION

In any debate over helping the low-income, we are caught in a triangle of competing social goals: helping the affected income groups, maintaining incentives for them to work and strive for themselves, and keeping the programme budget affordable. Any movement within this triangle must move away from at least one goal. Yet societies care not just about the size of the economy, but also social peace and cohesion. Finding the right blend of pro-growth policies and redistributive measures will be critical for sustaining the Singapore story of growth with equity.

NOTES

1. Department of Statistics, Key Household Income Trends (Singapore: Ministry of Trade and Industry, 2006).
2. The Economist noted that since 2000, real wages for the median US worker rose only about 1.5% even after accounting for health and pension benefits, even though productivity grew by as much as 15%.
3. Lindert, Peter H., Growing Public: Social Spending and Economic Growth since the Eighteenth Century (UK: Cambridge University Press, 2004).