unequal economy may have a tendency to push for higher redistributive public expenditures and transfers and higher taxes (assumed to negatively affect capital accumulation) to finance the additional spending. There is also the so-called sociopolitical instability approach (Alesina and Perotti, 1996) by which individuals in highly unequal societies will have incentives to engage in activities outside legal markets, such as crime and violence. For example, using a large panel of international homicide and robbery rates, Fajnzylber, Lederman and Loayza (2002) show that countries with higher inequality levels tend to have higher crime levels: on average a 1 percentage increase in the Gini coefficient appears to increase crime rates by between 1 and 4 percent. Finally, there are economic arguments linked to the existence of credit constraints (e.g. Galor and Zeira, 1993), by which such constraints coupled with fixed costs and indivisibilities can prevent poorer individuals from investing in education or physical capital.

Thus, there are good economic reasons, in addition to equity reasons, to be concerned about inequality. This paper, tries to contribute to this debate along several dimensions. First, it presents in Section II a review of the current situation of income inequality in the region. It also explores how inequality has evolved over the past few years and discusses some of the limits of standard indicators. Second, it discusses in Section III the reasons that the literature has put forward to understand the high levels of inequality in the region, namely an unequal distribution of assets and the inability of the state to correct income inequality through taxes and transfers. And third, it reflects in Section IV about the channels that may make inequality lead to lower growth rates and presents some new empirical results on the impact of inequality on output volatility.

# **II. Inequality in Latin America**

# _II.1 Inequality in Latin America_

As noted above, the average gini coefficient in Latin America is .52.<sup>3</sup> However this average hides significant regional variation. In fact, there are countries like Bolivia, Haiti or Jamaica with gini coefficients around .6.<sup>4</sup> At the other extreme, we can find two Caribbean countries (Trinidad and Tobago and Guyana) with a gini coefficient of .42 and Venezuela and Uruguay with close to .45 (Panel A, figure 1).

By any standard these levels of income inequality are extremely high. Panel B reproduces the previous chart but now accompanied by the gini coefficients of all the developing countries for which the World Bank povcal database<sup>5</sup> reports data. Inspection of this panel indicates that Latin America has the highest levels of inequality. For example, the average gini index in Sub-Saharan Africa (SSA) is .47. In the other developing regions it is much lower and ranges from .34 in Europe and Central Asia (ECA) to .38 in East Asia and the Pacific. Further, it is also worth noting that the most equal Latin American

> 3 The median gini is slightly higher and equals .54.

> 4 The data for Latin America was kindly provided by Leo Gasparini and it is based on the last available survey for each country.

> 5 The povcal database can be accessed at http://iresearch.worldbank.org/PovcalNet/jsp/index.jsp

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