Income Inequality Rises in Asia

Asian governments must spend more if they are to reverse the increasing income inequality that most have been showing for the past decade or more. That is the basic conclusion of an Asian Development Bank (ADB) study contained in its recently released 2014 edition of the Asian Economic Outlook.

This by no means the first time the ADB has focused on rising inequality as an impediment in much of Asia moving to middle income status. But the paper “Fiscal Policy for Inclusive Growth” puts the onus for improvement firmly on fiscal policy. In short, more money needs to be spent, particularly on education, health and direct transfers to the disadvantaged.

For once, Asia comes rather badly out of a comparison with Latin America. The article notes that fiscal policies in countries including Brazil have led to a noted improvement in income distribution at a time when Asian has been deteriorating. Although the Latin America started from a mostly much worse situation, it has shown that fiscal policy can work. It notes that the matter is especially serious as the nations which have seen the sharpest deterioration are also the most populous – China, India and Indonesia.

Needless to say, the ADB doesn’t favor abandoning the fiscal discipline which has characterized the majority of Asian countries, contributing to macro-economic and exchange rate stability. It also notes that taxation systems in themselves are far less important than spending for reducing inequality. So the main approach must be to increase revenue and expenditure more than make tax systems more progressive.

The report notes the low level of government revenue which characterizes much of Asia and which leaves little room for recurrent spending on health, education and well- directed transfers, the three most effective means of reducing inequality.

While acknowledging the role of infrastructure spending in promoting economic growth it suggests that there is little evidence that it does anything to reduce inequality as much of it goes to already relatively wealthy urban areas or to improving foreign trade prospects rather than benefitting the rural poor.

While some countries do need to spend more on physical infrastructure, others, it implies, need to focus much more on spending, which also increases output in both the short and long term – which includes public health and education. Health spending is especially weak in much of Asia.

Well directed transfer spending not only directly alleviates poverty but can be used to improve private commitment to education and health programs. However, in much of Asia such transfer spending as exists actually adds to inequality, fuel subsidies being the most obvious. Until recent reforms Indonesia’s fuel subsidy, which mainly benefited the car-owning minority, was equal to 4 percent of GDP or roughly three times public spending on education! Even education spending is often regressive by being over-focused on the secondary and tertiary sectors.

However the report does have some good things to say about the impact of Thailand’s health care – a key part of the Thaksin agenda – and its relatively modest fiscal cost, and recent efforts in China to reduce the imbalance in educational opportunities between urban and rural.

On the issue of how to raise more revenue the report recognizes that though a Value Added Tax (VAT) can be regressive it is relatively easy to implement and can be designed in a way to minimize its negative impact on the poor – and use its proceeds to reduce inequality. It also sees a place for capital gains and inheritance taxes.

But the ADB is especially keen on the use of property taxes, based on capital value, to fund local governments. It notes that in China local government is excessively reliant on sales of land leases – which are capital revenue – when annual property taxes would be more stable, efficient and equitable revenue source.

While making generalizations about Asian economies with widely varying economic and political systems and levels of development is always hazardous, the ADB has done a service in pointing to the central role of fiscal policy in reducing income inequalities. Of course there are many who assume that increasing inequality is an inevitable adjunct of growth.

However, in the case of Asia, that was disproved by Japan, Korea and Taiwan as they moved up the global income scale. And, as the ADB and others have pointed out previously, income inequality in upper middle income countries such as Thailand and Malaysia – and by implication also in China – is holding them back. Domestic demand other than for luxuries stagnates and capital is diverted into speculative activities or accumulation of foreign assets rather than raising manpower productivity.

The problems for Asia is that reversing inequality trends are being complicated by fast changing demographics flowing from decades of rising life expectancy and falling fertility rates. But whether countries are still at low income levels, have just reached middle income or now aspire to join the high income ranks, acceptance of the need for increased overall spending on health, education and transfers essential. That may not even need more taxes. Just making people and companies pay what they should, and ending subsidies to the top 20 percent of citizens would go a long way to reversing the trends to inequality.