'Credit redistribution could reduce savings'

Q&A/Francois Bourguinon

Poverty reduction is not merely a matter of raising economic growth, says Francois Bourguinon, senior vice president and chief economist at the World Bank.

The real solution to the problem lies in the relation between growth and income distribution in the economy and each country has to find its own unique policy prescriptions.

Bourguinon, who was in Delhi recently to deliver a lecture on "The Poverty-Growth-Inequality Triangle" at the Indian Council for Research on International Economic Relations, spoke to Business Standardon development-related issues.
Excerpts:

What are the areas where you would advocate reform for India?
The World Bank has been advocating India opening up more systematically to international trade. The recent lowering of peak customs duty is a unilateral decision and is a good sign.

Reform, however, is needed in other areas as well. The huge deficit level is a source for concern. India needs to reform either on the tax collection side or make public sector services more cost-effective, while ensuring that the public does not suffer.

Should the government focus on provision of social sector services or focus on areas like infrastructure?
The level of the budget deficit is a constraint and the government needs to prioritise. If the lack of infrastructure is a binding constraint, you have to invest there because the resulting economic growth will benefit all sectors.

For instance, in Tamil Nadu, water supply is a big problem that could, in time, hinder the entire development process in the state.

Therefore, they need to focus on water supply. In some cases, however, infrastructure is not an immediate bottleneck. The decision of where to invest requires an analysis of the cost and returns.

You mentioned that redistribution can be a growth-enhancing policy. What kind of redistribution policies would you advocate?
The redistribution of credit from the top to the bottom could increase the rate of return on investment and accelerate economic growth. But this could also reduce the level of savings in the economy.

In order to redistribute credit to people who can use it more effectively, the government could subsidise banks and financial intermediaries or non-governmental organisations undertaking micro-finance programmes.

They have to pick those that can channel the money most effectively. In such a situation, it pays to remember that non-performing assets are more likely to be on account of big companies than on account of small borrowers.

But countries have to choose carefully which policies to adopt. In some cases, redistribution can hamper growth in the short run. Consider the case of education or enhancing human capital.

Borrowers at the bottom end of income distribution have little collateral for educational loans. But it is difficult to redistribute wealth.

So, in order to redistribute human capital, we have to take a circuitous route and go via income redistribution.

That is, increase income tax for the rich and use the money to compensate the poor for the opportunity cost of sending children to school.

Such a policy could have an initial negative effect on the economy because increasing taxes worsens the investment climate in the economy.

One good way of achieving the optimal situation "" higher growth and better distribution "" is to get rid of subsidies that benefit people at the top of the distribution.

How should governments formulate subsidies?
Subsidies should target the poor. International experience shows that food subsidies are difficult to target. There is a lot of leakage and associated corruption.

Public employment programmes are an efficient way of transferring income to the people below the poverty line. Such programmes entail self-selection, in that only the genuinely needy come forward to seek such employment.

Mexico and Brazil are successfully following conditional cash transfer programmes. They identify people and give them cards, very often smart cards.

They are then given cash transfers conditionally on sending their children to school, or for sending them for medical tests twice a year and the like.

India is currently trying to introduce a comprehensive social security system. What is the international experience in regard to such systems?
In case of social security systems, it is extremely to difficult to cover people who are irregular in terms of employment in the formal sector. People who shift between the formal sector and self-employment or between the formal and informal sector pose problems.

Contributory pension systems, therefore, are very difficult to implement. It is easier to have a lump-sum provision for the elderly if they have no other sources of income.

Policies for the elderly are important with the rising proportion of people in the over-60 age bracket. South Africa, Brazil and Chile have pension systems and policies for the elderly that have worked fairly well.

India has reported healthy economic growth over the past few years. Poverty, however, continues to be a problem....
The absolute levels of poverty and poverty reduction depend on economic growth and on distribution. In India, the observed change in distribution is very limited, so relative poverty has not changed much.

However, growth has led to a decline in poverty. India is not a very clear case because of the controversy on the poverty reduction figures. The picture will be clearer once the results of next quinquennial round are out.

In the case of India, if per capita income increases at 4 per cent a year for 10 years, the percentage of people below the poverty line will drop from about 25 now to marginally less than 10 per cent.

India is a relatively egalitarian society with a gini coefficient of a little over 0.3. If the society were a little more unequal, with a gini-coefficient of 0.37, the reduction would be around 12 per cent, which means an additional 50 million people below the poverty line.

Globalisation has not always reduced poverty or inequality. So, why does the World Bank continue to advocate opening up to reduce poverty?
Economic theory states that multilateral opening up is bound to lead to an increase in a country's total income. But not everyone would benefit immediately. Governments need to make sure that everyone benefits in the long run and there is a need to compensate the poor in the process.

The right policy may not be to open up in all sectors at one go, but to go in for selective opening up. Developing countries must know that the way in which they open up is important.

The way international trade negotiations happen, however, makes that difficult. Developed countries want more liberalisation and are not willing to give much in return. They need to eliminate market protection.

But multilateralism does not seem to be delivering....
Multilateralism is the best way forward. But if that is not happening, the best solution is to focus on regional trade.

While this may not hold true for some countries, China, India, south and south-east Asia have enough momentum for regional growth. In fact, in the case of India and China, the internal markets are also very important.