Despite the rise in income disparities in the late 1990s, income inequality in the Republic of Latvia continues to fall within the range observed in most transition economies, probably as a result of existing redistribution and social transfer mechanisms. In fact, Latvia remains at the lower end of the range when compared to countries such as the Russia Federation, Moldavia, and most countries from the Caucasus and Central Asia region, which have Gini coefficients exceeding 40% (World Bank [2000b]).<sup>15</sup> The levels of income inequality in these other transition economies are comparable to the ones observed in a number of countries in Latin America where the pervasive asset and income inequality has been singled out as the most direct proximate causes of persistence in poverty (Londono and Székely [2000]). Moreover, most recent empirical evidence seems to suggest that the declining rate of growth in income inequality observed during the recovery phase of the transition has continued. This could be accelerated by the government’s decision to increase the minimum wage to reduce the income gaps between poor and non poor.

However, in the short- to medium-term, the continued rise in income inequality, albeit of smaller magnitude, is likely to negatively impact the prospects for poverty reduction in the recovery phase of the transitional period. There is ample empirical evidence suggesting that income inequality is negative for poverty reduction, even in countries experiencing high income growth, since the rate of decline in poverty tends to be slower than that observed in countries experiencing a more equitable growth. Assessing the relationship between income inequality, growth and poverty reduction, Martin Ravallion [2001] found that the median rate of decline in the proportion of the population living below US$1/day among countries with both rising average income and rising inequality was about 1.3% per year, significantly lower than the poverty reduction rates that would be in effect in a more equitable growth scenario characterized by increased average living standards and falling income inequality. Indeed, by contrast to the latter, the more equitable growth scenario produced a median rate of poverty reduction seven times higher (about 10% per year).<sup>16</sup> Similarly, a study assessing the welfare effects of income inequality at the regional level, and contrasting Latin American and Eastern European countries found that significantly lower poverty rates would be recorded in Latin American countries (LAC), with the proportion of population below the poverty line falling to less than 3 from 35 percent if the LAC region was growing at the same rate, but with the distribution of income mirrored by that observed in Transition Economies or East Asia (Londono and Szekely [2000]). This result clearly illustrates the contrast between countries in Transition Economies and countries in the LAC region on the income inequality scale. It highlights the potential welfare implications of highly unequal distribution of income. The study also reveals a strong correlation between income inequality and worsening poverty, with headcount above 40 percent in countries with Gini exceeding 57.<sup>17</sup>

> 15 High income inequality among these countries include Armenia, Turkmenistan, Tajikistan, Kyrgyz Republic and Georgia.

> 16 For further details, see Ravallion [2001].

> 17 The four countries with the largest Gini coefficients also recorded the largest headcount index. These countries include Brazil, Guatemala, Honduras and Panama. Brazil which has the largest Gini (61.4) had a headcount index of 44%; Honduras which has a Gini coefficient of 57 recorded the largest poverty rate of 65.6% (Londono and Szekely [2000]).

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