Asia continues to be the world’s growth leader, but the gains from growth are less widely shared than before. Until about 1990, Asia grew rapidly and secured large gains in poverty reduction while simultaneously achieving a fairly equitable society. Since the early 1990s, however, the region has witnessed widening income inequality that has accompanied its robust expansion—a break from its own remarkable past.
This matters because elevated levels of inequality are harmful for the pace and sustainability of growth. What can be done? Our research finds that policies could substantially reverse the trend of rising inequality. In particular, given limited social safety nets, well-designed fiscal policies may be able to alleviate inequality without stifling the region’s wealth-creating growth.
Home to more than half of the world’s population, Asia remains the engine of global growth. It is expected to grow at 5.5 percent in 2016 and account for almost two thirds of global expansion this year and next. After more than two decades of rapid economic development, incomes rose across all segments of Asia’s population. Though millions have been lifted out of poverty thanks to the growth dividend alone, the IMF’s Regional Economic Outlook for the Asia and Pacific shows that economic development has not benefited the region’s populations equally or at the same pace, causing the region’s income disparity to grow.
Indeed, income inequality has risen in most of Asia, in contrast to most regions. In some larger countries, including China and India, spatial disparities, in particular between rural and urban areas, explain much of the increase. Since 1990, China’s economy has recorded the steepest growth but also a large increase in income inequality. In India, the gap between the income share of top and bottom earners also grew significantly (Figure 1).
While global factors, such as technological change that puts a premium on skills, help explain inequality anywhere in the world, regional and country-specific factors influence the growing discrepancies between income levels of different populations in Asia. Asia seems to be unique not just in its pattern of high and sustained economic growth, but also in the distinctive effect of various policy-related inequality drivers. For example, financial deepening, which tends to be associated with higher inequality in other parts of the world, has had an equalizing effect in Asia. In a number of Asian economies, government policies have successfully sought to expand the coverage of financial services, giving low-income households and small and medium-sized enterprises access to credit.
On the other hand, in contrast to other regions, where education and social benefits function as economic equalizers, they have failed to reduce income inequality in Asia and even tend to increase it. Progressive taxation predictably ameliorates income inequality in Asia, just as it does in other parts of world. However, poorly targeted policies are partly to blame for failure of expenditure to alleviate income inequality. Moreover, social safety net spending is relatively low in Asia compared with the rest of the world (Figure 2), and lower revenue collection translates into lower coverage of spending, including, for example, on social insurance.
Let’s put it in a more global, comparative context. At 22 percent, the share of retirees in Asia who receive a pension is among the lowest in the world – about the same as in Sub-Saharan Africa and approximately one-fourth the level in advanced economies or in Emerging Europe (Figure 3). Unemployment benefits are similarly low, and like all other social benefits, distributed unequally. The spotty reach of social-benefits spending, combined with poorly targeted spending that disproportionately benefits the more affluent, puts a strain on the countries’ budgets without meeting the equalizing social purpose of these fiscal policies.
Furthermore, Asia also faces considerable inequality of opportunity (as do other regions), which is of critical importance since it delinks economic outcomes from an individual’s efforts and thus entrenches income disparities that prevent the emergence of a substantial middle class. Lack of access to education and health services can worsen education and health outcomes, hampering productivity and perpetuating income inequality. Also, the inadequate financial services also constrains the ability of people, particularly low-income individuals, to borrow for investment and to finance education spending.
So what can be done to reverse this trend of rising inequality in Asia? Strengthening the redistributional effect of fiscal policy could help without endangering the region’s poverty-reducing growth. On the tax side, broadening the base for income and consumption taxes while making them more progressive is important, but it cannot be achieved without better compliance to support effective tax collection. On the spending side, designing well-targeted transfer programs while avoiding costly universal price-subsidy schemes is essential, as is improving and broadening access to health services and higher education to raise earnings potential and reduce income gaps.