Strong economic growth a prerequisite for poverty reduction, improved quality of life

23 Aug 2018

According to Department for International Development (DFID) policy paper on “Building Jobs and Prosperity in Developing Countries”, growth can generate virtuous circles of prosperity and opportunity. Strong growth and employment opportunities improve incentives for parents to invest in their children’s education by sending them to school. This may lead to the emergence of a strong and growing group of entrepreneurs, which should generate pressure for improved governance.

Under different conditions, similar rates of growth can have very different effects on poverty, the employment prospects of the poor and broader indicators of human development. The extent to which growth reduces poverty depends on the degree to which the poor participate in the growth process and share in its proceeds. Thus,both the pace and pattern of growth matter for reducing poverty.

According to the policy paper, a successful strategy of poverty reduction must have at its core measures to promote rapid and sustained economic growth. The challenge for policy is to combine growth-promoting policies with policies that allow the poor to participate fully in the opportunities unleashed and so contribute to that growth. This includes policies to make labour markets work better, remove gender inequalities and increase financial inclusion.

Future growth will need to be based on an increasingly globalised world that offers new opportunities, but also new challenges. New technologies offer not only ‘catch-up’ potential but also ‘leapfrogging’ possibilities. New science offers better prospects across both productive and service sectors.

Future growth will also need to be environmentally sustainable. Improved management of water and other natural resources is required, together with movement towards low carbon technologies by both developed and developing countries. With proper institutions, growth and environmental sustainability may be seen as complements, not substitutes.

“More and better research on the drivers of growth will be needed to improve policy. But ultimately the biggest determinants of growth in a country will be its leadership, policies and institutions,” according to the policy paper.

The central lesson from the past 50 years of development research and policy is that economic growth is the most effective way to pull people out of poverty and deliver on their wider objectives for a better life.

Research that compares the experiences of a wide range of developing countries finds consistently strong evidence that rapid and sustained growth is the single most important way to reduce poverty. A typical estimate from these cross-country studies is that a 10 percent increase in a country’s average income will reduce the poverty rate by between 20 and 30 percent.

The central role of growth in driving the speed at which poverty declines is confirmed by research on individual countries and groups of countries. For example, a flagship study of 14 countries in the 1990s found that over the course of the decade, poverty fell in 11 countries that experienced significant growth and rose in three countries with low or stagnant growth. One average, a one percent increase in per capita income reduced poverty by 1.7 percent.

Among these 14 countries, the reduction in poverty was particularly spectacular in Vietnam, where poverty fell by 7.8 percent a year between 1993 and 2002, halving the poverty rate from 58 percent to 29 percent. Other countries with impressive reductions over this period include El Salvador, Ghana, India, Tunisia and Uganda, each with declines in the poverty rate of between three and six percent a year.

Driving these overall reductions in poverty was the rebound in growth that began for most of the countries in the mid 1990s. The media Gross domestic Product (GDP) growth rate for the 14 countries was 2.4 percent a year between 1996 and 2003.

Numerous other country studies show the power of growth in reducing poverty and Mozambique illustrates the rapid reduction in poverty associated with over a shorter period. Between 1996 and 2002, the economy grew by 62 percent and the proportion of people living in poverty declined from 69 percent to 54 percent.

The positive link between growth and poverty reduction is clear. The impact of the distribution of income on this relationship – in particular, whether high inequality lessens the reduction in poverty generated by growth – is less clear.

Initial levels of income inequality are important in determining how powerful an effect growth has in reducing poverty. For example, it has been estimated that a one percent increase in income levels could result in a 4.3 percent decline in poverty in countries with very low inequality or as little as 0.6 percent decline in poverty in highly unequal countries.

The policy paper however cautions that such calculations need to be interpreted with care given the multitude of variables involved. Even if inequality increases alongside growth, it is not necessarily the case that poor people will fail to benefit – only that they will benefit less from growth than other households.

But contrary to widespread belief, growth does not necessarily lead to increased inequality. While some theoretical research suggests a casual relationship between growth and inequality (and vice versa), the consensus of the latest empirical research is that there is no consistent relationship between inequality and changes in income.

The experiences of developing countries in the 1980s and 1990s suggest that there is a rough equal chance of growth being accompanied by increasing or decreasing inequality. In many developing countries, rates of inequality are similar or lower than in developed countries. A series of studies using cross-country data all suggest that growth has neither a positive nor a negative effect on inequality.

The policy paper emphasizes that economic growth generates job opportunities and hence strong demand for labour, the main and often sole asset of the poor. In turn, increasing employment has been crucial in dele3ivering higher growth. Strong in the global economy over the past 10 years means that the majority of the world’s working-age population is now in employment.

At the same time, in every region of the world and particularly in Africa, youth unemployment is a major issue. This is reflected in higher than average unemployment rates: young people make up 25 percent of the working population worldwide but 47 percent of the unemployed.

The policy paper further points out that real wages for low-skilled jobs have increased with GDP growth worldwide, which indicates that the poorest workers have benefited from the increase in global trade and growth.

Fears that greater global integration and ever more ‘foot loose’ international investors would push down wages have proved to be unfounded. Indeed, evidence on foreign direct investment suggest that firms attracted to countries with higher, not lower, labour standards.

Macroeconomic factors, such as low inflation, export orientation and low labour taxes, help to determine how much employment is created by growth. Structural factors, such as the balance of the economy between agriculture, manufacturing and services, are also important.

While the relationship between growth and employment remains robustly positive, the strength of the link has weakened since the turn of the millennium according to the policy paper, raising concerns about ‘jobless growth’ in some countries.

Even if the relationship between growth and employment is weakening, this may suggest a stronger rationale for a higher growth strategy in the future. Furthermore, the trend may mask improvements in productivity that could provide the basis for the creation of even more job opportunities in the long term.