The FINANCIAL — In the first part of this article (available on the homepage of The Financial and the ISET Economist Blog), I described some of the adverse incentives resulting from a social welfare system. Then I argued that according to Simon Kuznet’s famous paradigm, increasing inequality is hardly evitable when a country enters a growth trajectory (as Georgia did in 2003), and I reasoned that it is at least an ambivalent (not to say questionable) policy for Georgia, at its current state of development, to fight inequality by social welfare measures.
In this vein, the article seemed to advocate that Georgia might better follow the “Asian” approach of “develop first, redistribute later”. This, however, is not the end of my story! The second part of the article points out that the Asian model is unlikely to fit Georgian culture and values, which is more a European than an Asian country. Moreover, it will be shown that the contradiction between redistribution and growth is not as clear-cut as suggested by neoclassical economics.
Some weeks ago, Dr. Donghyun Park, senior economist of the Asian Development Bank (ADB), presented the ADB Outlook 2014 at ISET. After his presentation, someone in the audience asked whether Georgia should forget about inequality for a while and rather concentrate on growth, a policy pursued by many former developing countries in Asia. In response to this question, Dr. Park answered that Georgia’s culture and history might be incompatible with such a policy. Georgia, by its religion, culture, and history, is a European country, and in Europe people are very sensitive about the living conditions of other citizens. Unlike in Central and East Asia, where the society is much more stratified (consider the Caste system in India or traditional hierarchies in Japan), the European Christian and Socialist traditions focus on the living conditions of the poor members of society. In this view, which is politically very influential in Europe, excessive inequality obstructs the well-being of the whole population. Prudent policy takes such cultural idiosyncrasies into account, and Georgia should thus choose policies that fit to the predominant Georgian values.
One might add that Georgia, unlike successful Asian countries like Korea, Hong Kong, and Japan, faced very unique challenges that resulted from the transition from a planned economy to a market economy. Unlike China, which deliberately chose to stretch the transition processes over several decades, the abrupt collapse of the Soviet Union forced the Georgian economy to transition within a very short time span. This is related to the question of values, as the “economic big bang” that occurred 24 years ago produced a lot of economic losers (the part of the society having difficulties to adjust to the new system, like middle-aged and old people whose human capital was devaluated in a fortnight). Just a very small share of the society could profitably exploit the breakdown of the Soviet Union, creating a large gap between the upper and the bottom income groups of the society. Unlike in Asia, where inequality was the result of longer historical processes, in Georgia inequality popped up instantaneously.
The collapse of the Soviet Union also weakened the middle class, which in many countries is the core of the “civil society” and as such is an important driver of political and economic reforms that go beyond special interests. Moreover, the lack of a middle class increases the risk of political instability and social turmoil.
THE POLISH RECIPE
It is an interesting fact that sharp inequality struck all post-soviet and Eastern Bloc societies except one: Poland. Poland is the only transition country that achieved relatively high economic growth without excessive inequality. According to a 2002 paper of Michael P. Keane and Eswar S. Prasad (“Inequality, Transfers, And Growth: New Evidence From The Economic Transition In Poland,” The Review of Economics and Statistics 84, pages 324-341), after it achieved independence Poland immediately devoted substantial resource to social transfers. As Keane and Prasad point out, this policy yielded a couple of benefits. First of all, it avoided any social instability, which – to varying extents and degrees – struck many other transitioners. Ukraine, up to this day, has not achieved any political stability, and it is not difficult to imagine how this fact influences investors’ decisions to engage either in Poland or Ukraine. Secondly, preventing the middle class from evaporating led to a civil society which strengthened democracy and prevented the usurpation of power by autocrats, something which happened in many post-soviet societies. Thirdly, transfers were targeted at those people who were the primary losers of the transformation (Poland paid high pensions to old people and provided generous cash transfers to the bottom income groups). This led the transformation appear in a warmer light, made it more acceptable, and catered the Christian mindset of the Polish people.
These advantages seem to have outweighed the adverse effects of transfer policies, and Poland could enjoy solid growth and low inequality during the first eight years of transition.
“There is no one-handed economist”, they say, meaning that economists always come up with pros and cons on every question. This is definitely the case with the subject matter of this article. While the Asian approach has proved to be highly effective in developing certain countries, also the European way has its advantages. Whether the one or the other approach is better must be decided on a case-by-case basis.
In August 1996, US President Bill Clinton signed a law that gave incentives to welfare recipients to return into regular employment. This policy, generally known as “workfare”, is essentially still in place today. Unlike a traditional welfare system, under the workfare system people receive benefits based on their efforts to improve their job market prospects. Rewarded are, among others, training efforts, acquisition of work experience through internships and unpaid jobs, rehabilitation (like efforts to end alcoholism and other addictions), and contributions to the society (such as honorary offices and unpaid social work).
Surprisingly, many economists at that time believed that this law would sharply increase poverty, as they doubted that poor and often socially degenerated people would be sensitive to economic incentives. Yet between 1993 and 1999 the US unemployment rate fell by 2.7 percentage points and the poverty rate dropped from 15.11% to 11.3%. The number of families depending on social benefits fell from 5 to 2 million. Today, most economists agree that workfare was a successful idea, as it provided relief to poor families without promoting idleness and transfer dependency.
Another approach, currently very fashionable in the development economics scene, is the idea of inclusive growth. According to this theory, there are different kinds of growth, and not every growth necessarily increases inequality. The task of the government is to identify those economic sectors which are inclusive and then foster their development. Whether this is feasible and promising is a topic hotly debated among economists, and since last year, ISET was proud to host a dialogue series with expert panels on inclusive growth in Georgia (on behalf of the Swiss Development Corporation). There are still two dialogues to come, and people interested in this exciting topic can find all information on the webpage of ISET-PI.