The pursuit of equity threatens poverty alleviation 

ARVIND PANAGARIYA

Recent election victories by the Marxist Communist party in the Indian states of West Bengal and Kerala, the strong showing by Ollanta Humala in the first round of Peru's presidential election, the election of Evo Morales as Bolivian president and land grabs by local officials in China have re-energised leftwing critics of pro-market policies in the developing world.

They had previously argued that such outward-orientated policies led to increased poverty, but the evidence from China and India has decisively laid that charge to rest. Therefore, they have now shifted their critique to equity, arguing that market reforms widen the gap between rural and urban populations. They further claim that this lamentable phenomenon is turning the citizens of India, China and Latin America away from reforms.

But the argument is wrong and pernicious. These critics have not only diagnosed the above developments incorrectly, they seem oblivious to the dismal history of equity-driven policies in the developing world. For a start, it is premature to assert that Latin America is turning away from reformist policies. In March, Costa Rica handed the presidency again to Nobel laureate Oscar Arias, who says he firmly believes in democracy, free markets and fiscal discipline. Colombia has just given Alvaro Uribe, the reformist president, a landslide re-election victory.

Even the victories by a few left candidates reflect Latin America's maturing democracy rather than a leftward march. The policies of Luiz Inacio Lula da Silva, the Brazilian president, can hardly be described as antithetical to globalisation. The same applies to Michelle Bachelet, Chile's new president. Even Mr Morales's election had its origins in the indigenous majority asserting itself rather than a red revolution. Finally, in Peru's June 4 run-off, polls now overwhelmingly favour Alan Garcia, who wants to ally his country with the pro-reform governments of Brazil, Chile and Colombia.

In China, the land grabs are to be attributed to the absence of democratic institutions rather than to rising rural-urban inequality. When a commissar or his cronies grabs your land in China, especially if it becomes more valuable with growth, you cannot turn for redress to democratic institutions.

In India, aspirations aroused by rapidly rising incomes, rather than by inequality, have been translated into politically effective demands for yet more improvement, as reflected in the frequent uprooting of incumbent governments. The victory of the Marxists in Kerala over the incumbent Congress fits this pattern. As for the Marxist leadership in West Bengal, which has been repeatedly returned to power, it has fully embraced market-orientated reforms and unabashedly courts foreign investors and captains of industry.

But if inequality is a red herring, the faulty diagnosis also endangers the process of growth and poverty alleviation. No country illustrates this better than India, which placed equity at the centre of policymaking in the earlydecades of development with devastating results. Virtually all anti-growth and anti-poor policies India has been struggling to shed for two decades had their origins in the pursuit of equity.

Thus, the desire to establish a socialistic pattern of society was at the heart of the dominant role Indian policymakers assigned to the public sector in industry. When the relatively relaxed investment and import licensing regime of the 1950s led to rapid growth of private industry, it was concern for equity that led Indira Gandhi, then prime minister, to erect the massive regulatory structure that even 20 years of reforms have not been able entirely to demolish. To cap the concentration of economic power, Gandhi confined all future investments of undertakings with assets exceeding Dollars 27m to 19 capital-intensive "core" industries. To encourage small entrepreneurs, she went on to reserve virtually all labour-intensive products, exported in large volumes today by China, for exclusive production by small-scale units. Considerations that large banks did not adequately lend to smaller enterprises or open rural branches led Gandhi to nationalise them. Undertakings with 100 or more workers were denied the right to fire employees.

To be sure, equity-orientated policies that improve opportunities for the poor without compromising efficiency and growth do exist. The catch, however, is that once equity becomes central to policymaking, self-interested lobbies
capture the policies in the name of fairness. The policies then adopted are precisely those that impede growth and poverty alleviation.

Financial Times May 31, 2006