# **1. Introduction**

Over the past decade Latin America has experienced strong income growth, particularly in the lower deciles of the income distribution, generating a notable reduction in income inequality. From 2003 to 2012, mean real per capita income grew by 3.3 percent, while for those individuals in the bottom 40 percent of the income distribution it grew by 5 percent. Over the same period, the regional Gini coefficient (pooled for 17 countries)<sup>1</sup> fell from 55.6 to 51.8 and declined in all 17 countries for which frequent household survey data is available.<sup>2</sup> Reductions in inequality are important for lifting more people out of poverty since lower inequality generates a higher elasticity of poverty reduction to economic growth. While two-thirds of the observed decline in poverty in Latin America between 2003 and 2012 can be explained by economic growth, the other third can be broadly explained by improvements in the income distribution - though the contribution of the latter has risen since the Financial Crisis.<sup>3</sup> Moreover, different countries have translated growth into declines in poverty at different rates – i.e. the growth elasticity of poverty reduction has varied considerably between countries in Latin America. But in general, those countries with lower level of income inequality have experienced a higher growth elasticity of poverty reduction.<sup>4</sup> Several studies have shown evidence of a steady decline in income inequality in Latin America over the first decade of the 2000s (Gasparini et al. 2008; Lustig and Lopez-Calva 2010; World Bank 2011; Lustig, Lopez-Calva and Ortiz-Juarez, 2013; de la Torre et al. 2014). This result is robust to the choice of time periods, income variable, inequality measures and data sources. These studies also find that this decline in inequality has been driven mostly by improvements in labor income. In particular, by a reduction in skill premiums, reflecting a combination of improved access to education thus increasing the supply of skilled workers and lowering excess demand for skilled labor (Gasparini et al. 2011). In addition, this body of literature has concluded that public monetary transfers have contributed to the

> 1 Since the Gini coefficient does not satisfy group decomposability, the regional Gini coefficient is computed based on pooled country-specific data for 17 countries. These include: Argentina (urban only), Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru and Uruguay (urban only). When no data for a country is available for a specific year, the distribution was interpolated using data from the nearest years available. To address missing data at the end of the series, the distributions were extrapolated based on the growth of national consumption reported in the World Development Indicators (WDI). Excluding these extrapolations from the aggregate did not qualitatively change the results.

> 2 Alternative measures of regional inequality show similar trends: between 2003-2012, inequality measured as the unweighted average of country Gini coefficients declined from 53.8 to 48.3 while the population-weighted average declined from 54.9 to 50.3.

> 3 Between 2003 and 2007, about 73 percent of moderate poverty reduction ($4 a day) was due to economic growth and the remaining 27 percent due to changes in the income distribution; this number declined to about 56 percent for economic growth and 44 percent for redistribution between 2007 and 2012 (World Bank, 2014a)

> 4 For instance, since 2003, Mexico has had low GDP growth (about 0.7% per year), but poverty levels have been very sensitive to the growth (about 2% of poverty reduction for each one percentage increase in GDP growth), while the Dominican Republic experienced high GDP growth but observed a very low effectiveness of growth to reduce poverty (about 0.2% of poverty reduction for each one percentage increase in GDP growth) (World Bank, 2013).

1