# **I. Introduction**

With an average gini coefficient of .52, Latin America stands out as one of the two<sup>1</sup> most unequal regions of the world. In addition to the fact that citizens dislike such high levels of inequality (according to the Latinobarometro, in 2001 almost 90 percent of the population of the region considered the distribution of income in the region to be unfair or very unfair), there are good economic reasons for policy makers to be concerned with this situation.

First, for a given average income per capita level, higher inequality implies higher poverty levels. Moreover, beyond this qualitative assertion, the impact of inequality on poverty is quite significant from a quantitative point of view. A simple simulation, assuming a log normal distribution of income per capita,<sup>2</sup> suggests that if Latin America had the inequality levels prevalent in Europe, the poverty rate (headcount, 2$PPP) would be closer to 12 percent than to the current estimate of 25 percent, at current levels of average income per capita.

Second, not only high inequality leads to higher poverty levels at current income levels, but it constitutes a barrier to poverty reduction. There are a number of studies (Bourguignon, 2003; Ravallion, 1997, 2004; Lopez and Serven 2006a; Perry et al, 2006) that show that the growth elasticity of poverty reduction is lower (in absolute value) in countries with high levels of income inequality. In other words, countries with higher inequality levels require a faster growth rate to achieve the same poverty reduction than countries with low inequality. Once again the differences between high and low inequality countries are sizeable. The results in Ravallion (2004) indicate that depending on a country’s initial gini coefficient, the growth elasticity of poverty could range from almost -5 (very low inequality countries) to -.5 (very high inequality countries). Thus the growth elasticity of poverty can be multiplied by a factor of 10 as a result of lower inequality. More specifically, a country like Brazil would need to grow at close to 5 percent per annum –if inequality levels remain constant- to achieve the same reduction in poverty levels than Poland could achieve by growing at just 2 percent in per capita terms.

A third reason to be concerned about high inequality is that it appears that countries with higher inequality and poverty levels tend to grow less (see, among others, Alesina and Rodrick 1994; Perotti 1996; Lopez and Serven, 2006; Perry et al, 2006). True, there are also studies that find that inequality leads to faster growth (Li and Zou, 1998; Forbes 2000) and studies that find no relationship at all (Barro, 2000), but in general this is usually the case of studies that focus on the short term impact of changes in inequality on growth.

What are the reasons put forward in the literature to explain these findings? The economic literature suggests several potential channels. There is, first, the political economy argument (Alesina and Rodrick, 1994) by which the median voter of a highly

> 1 The other being  Sub Saharan Africa.

> 2 More specifically to make this simulation we are assuming that per-capita income follows a log-normal distribution (see Lopez and Serven, 2006 for details).

2