STILL DIVIDED: SWIMMING-POOL ECONOMICS HAUNT LATIN AMERICA / THE ECONOMIST

Still divided

Swimming-pool economics haunt Latin America

Its tax and welfare systems are shockingly bad at reducing inequality

TO SEE REALITY in the Buenos Aires suburb of San Isidro, consider the drone’s-eye view (pictured). 

A razor-straight line divides lush gardens and smooth clay tennis courts from a mess of corrugated iron roofs in one of the city’s “villas miserias”. 

Santa Fe in Mexico City looks similar, the jewel-green of the golf club hemmed in by endless concrete boxes of the city’s strugglers. 

Rio de Janeiro’s favela of Rocinha sees makeshift dwellings spiral down the mountain, all but crashing into the turquoise swimming pools below.

Such visceral inequality is the defining feature of Latin America’s economies. 

The disparities in the region are rivalled only by those in sub-Saharan Africa. 

Yet because inequality is usually lower in richer places, and Latin America’s GDP per person four times that in Africa, its inequality is extraordinary. 

Some countries such as Colombia and Guatemala are extremely unequal, others such as Uruguay less so. 

Yet there are no exceptions. 

The World Bank does not class a single country in the region as “low-inequality”.

This shapes Latin America in countless ways beyond bird’s-eye photography: physically, through the proliferation of high fences and security cameras; politically, in populism and leftward lurches; and economically, through low social mobility, large informal economies and weak internal demand. 

The Economist will publish several articles this year exploring this dynamic. 

To start, it helps to understand why Latin America made good progress to reduce inequality in the 2000s, and why that progress has slowed.

The most common way to measure inequality is the Gini coefficient. 

This ranks a country’s income inequality between zero and one. 

Zero means everyone in the country gets the same income; one means a single person receives everything. 

Other kinds of inequality matter, too, but none transcend income. 

Unequal access to good education and health care are both outcomes of income inequality as well as being important causes of it.

The broad trend in Latin America is clear: inequality rose through the 1990s, peaked in about 2002 and then began to fall. 

Around 2014 the decline began to slow, and recently it has flatlined (see chart 1). 

There are exceptions—the Gini coefficient is still falling, though more slowly, in Peru and has been rising in Colombia—but the overall trend is plain.

Two things drove the decline between 2000 and 2010. 

One was government handouts. 

Conditional cash-transfer programmes such as Bolsa Família in Brazil gave money to poor families if they sent their children to school and for health check-ups. 

Across the region, transfer programmes of all kinds accounted for about 20% of the fall in inequality on average. 

A second factor mattered much more: strong growth in wages for the poor. 

This accounted for over half of the fall. 

The backdrop to this was a long period of robust economic growth, helped along by a commodities boom. 

The lesson, says Ana María Ibáñez of the Inter-American Development Bank (IDB), is that “If we want to reduce inequality, we need to grow.”

There is a series of smaller problems, too. 

One is the heavy influence of family background. 

A paper by Paolo Brunori of the University of Florence and co-authors finds that more than half of the current generation’s inequality is in effect inherited, largely as a result of their parents’ level of education and type of jobs.

Bosque Real Country Club and Golf Course, next to the Lomas del Cadete neighborhood in the foothills of Mexico City / Photograph: Johnny Miller

Rocinha, perhaps Latin America's most famous favela, sits on a steep mountainside with Rio's famous south zone in the background. / Photograph: Johnny Miller

To see how this works, consider the cycle a family background can set off. 

As Ms Ibáñez and co-authors explain, toddlers of richer parents often get better food and more attention, so develop more skills. 

This helps them take advantage of the better (often private) schools they attend, which in turn push them on to university where attendance strongly boosts earnings in Latin America, in large part by helping students get formal jobs in big companies. 

Children born into poorer families tend to go to worse schools, often don’t make it to university and end up working in Latin America’s large, less productive informal sector. 

And so the cycle revolves.

When inequality was falling, strong economic growth boosted poor Latin Americans’ wages, helping break the cycle. 

Yet growth has stalled horribly. 

Real income per person in Latin America and the Caribbean increased by a dismal 4% in total between 2014 and 2023. 

In South Asia, by contrast, it increased by 46%.

Governments have turned to other less effective remedies. 

A popular choice is to up the minimum wage. 

Mexico’s last president, Andrés Manuel López Obrador, doubled it in real terms during his six years in office. 

Claudia Sheinbaum, his successor, has promised annual increases of 12%. 

This has helped reduce poverty and inequality in Mexico, in part because the minimum wage was very low when Mr López Obrador took office. 

But there are limits. 

If productivity does not also increase, a rising minimum wage tends to increase informal jobs, dragging people back into the inequality feedback loop.

Governments also hope redistribution can deal with inequality. 

The immediate problem with this is that soft growth means thin government revenues, so less money to redistribute. 

Still, Latin American tax and welfare systems could do far better. 

When the region’s income inequality is measured before taxes and redistribution, it is only slightly higher than in rich countries. 

But whereas taxes and transfers reduce the Gini coefficient by almost 40% in rich countries, in Latin America they only reduce it by about 5%. 

Shockingly, in about half the region this translates into an increase in poverty.

The biggest problem is taxation. 

Across the OECD, a club of mainly rich countries, personal income taxes, which are usually progressive, are worth 8% of GDP. 

In Latin America they are worth just 2%. 

Instead, the region relies more on indirect taxes, such as VAT on goods and services (see chart 2). 

These are often regressive, as the rich and poor pay the same rate but the poor consume a larger portion of their income, so are hit harder.

Many welfare programmes are also riddled with problems. 

An IDB study of transfer programmes in 17 countries found that targeting is wayward. 

Only about half of people living in poverty benefit, while about 40% of those not in poverty get at least one kind of transfer. 

The amounts being transferred are often too small.

The circle is still vicious

Fixing this could put a big dent in inequality. 

But even as anger about disparities dominates election campaigns and sometimes explodes in the streets, as it did during violent protests in Chile in 2019, there is little progress. 

Though cross about the status quo, voters are not keen to change tax and welfare systems either. 

A study by Matias Busso of the IDB and co-authors surveyed eight countries and found that, while respondents are unhappy about inequality and support redistribution in theory, they are reluctant to pay extra taxes to fund it. 

One reason is that many mistrust the state and ruling elites.

All this adds up to a daunting challenge. 

Sustained growth, last seen over a decade ago, would provide the sharpest relief. 

Political reforms that build trust in government and allow for improvements to taxation and welfare would help. 

Both would be ideal. 

Neither seems likely.