82533 THE WORLD BANK Inequality in Focus Analyzing the World Bank’s Goal of Achieving “Shared Prosperity” This question-and-answer article was written col- laboratively by Inequality in Focus staff writer Maximillian Ashwill and the three authors of the forthcoming publication, “Shared Prosperity: Links to Growth, Inequality and Equality of Opportunity,” Jaime Saavedra-Chanduvi, Ambar Narayan, and Sailesh Tiwari. T he World Bank recently adopted new metrics for achieving the goal of ending global poverty. Specifically, this goal is to be reached by ending extreme levels of poverty and promoting “shared pros- perity.” Ending extreme poverty has been defined as reducing “the percentage of people living with less than $1.25 a day to no more than 3 percent globally by 2030.” In contrast, promoting shared prosperity is defined as “fostering income growth of the bottom 40 percent of the population in every country” (World Bank, 2013). This focus on improving the income growth of the poorest 40 percent is a departure from the traditional practice of focusing on per capita GDP growth rates. GDP growth rates are useful summary measures of a society’s economic progress but they are Maximillian Ashwill/World Bank unable to capture the distributional aspects of growth: It is entirely possible for a country to be growing rapidly on average while the poor within the country significant reinvigoration of the Bank’s commitment to see their incomes stagnate. These goals represent a working toward improving the living standards of the Poverty Reduction and Equity Department : : www.worldbank.org/poverty : : Volume 2, Number 3 : : October 2013 Figure 1 Growth Rate of the Bottom 40 Percent and Growth Rate of the Total Population 15 Consumption growth of the bottom 40% is positive and Consumption growth of the bottom 40% 13 faster than overall consumption growth. 11 9 Malaysia 7 Cambodia China Uganda Brazil Bolivia 5 Consumption growth of the 3 bottom 40% is positive but Philippines slower than overall (%) consumption growth. 1 Egypt -5 -3 -1 -1 1 3 5 7 9 11 13 15 -3 Consumption growth of the total population (%) -5 Source: PovcalNet as of September 20, 2013, and micro data from regional databases of LAC and ECA regions. most downtrodden populations with a sharper equity for those who are less well-off, the growth of average lens, even in wealthier countries where instances of incomes will not accrue proportionately to the bottom extreme poverty or destitution may be low. Recently, segments of the distribution. Thus, shared prosperity, a group of World Bank economists, Ambar Narayan, understood in this way, is not an agenda of redistrib- Jaime Saavedra-Chanduvi, and Sailesh Tiwari, explored uting an economic pie of a fixed size. Rather, the pie the relationship between shared prosperity with growth, must be expanded continuously and shared in such inequality, and inequality of opportunity. They traced a way that the welfare of those at the lower end of potential pathways toward achieving shared prosperity the income distribution rises as quickly as possible. (Narayan, Saavedra-Chanduvi, and Tiwari, forthcom- Shared prosperity also requires that progress is sus- ing 2013). The authors discuss their findings below. tainable from generation to generation, in terms of the environment, social inclusion, and fiscal prudence. How is “shared prosperity” different from “overall prosperity”? How is the goal of shared prosperity related to the There is a high, positive association between income goal of poverty reduction? growth of the bottom 40 percent and growth in aver- Given that the bottom 40 percent of incomes in age household income (figure 1). However, in situ- many countries overlaps strongly with those below the ations where inequality is high or rising, especially poverty line, one can expect a high correlation be- when it coexists with limited access to opportunities tween the growth rate of the bottom 40 percent and a 2 : : October 2013 : : Inequality in Focus reduction in poverty rates. Three con- Figure 2 Number of Countries Shown clusions can be drawn from our sam- by the Speed of Growth Rate of Bottom 40 Percent ple of 79 developing countries on this relationship. First, as expected, the growth rate of the bottom 40 percent is correlated with a reduction in pov- erty based on the two commonly used poverty lines: the extreme poverty line ($1.25/person/day) and the moder- ate poverty line ($2.50/person/day). Second, the magnitude of the correla- tion is higher for the moderate poverty line. This suggests that, on average, the bottom 40 percent of a country has a larger overlap with the popula- tion living below $2.50/day, which is Note: G40 is the growth rate of the bottom 40% of the distribution, while G* is the poverty line more applicable to the average per capita growth rate of the entire country. middle-income countries, than it does Source: PovcalNet as of September 20, 2013, and micro data from regional databases of LAC and ECA regions. with those living in extreme poverty ($1.25/day). Finally, the correlations population, which is 3.1 percent. In fact, in roughly are imperfect (-0.28 and -0.44 respectively for $1.25 two-thirds of the countries in the sample, the growth and $2.50 respectively), regardless of the poverty line rate of the bottom 40 percent was higher than the used, suggesting that the shared prosperity measure average growth rate. The fact that the bottom 40 per- is different from an absolute poverty measure. The cent were “catching up” in some sense implies that lower correlation between reducing extreme poverty inequality was declining in these countries. and promoting shared prosperity (measured through A third, related point that emerges is that a faster income changes of the bottom 40 percent) confirms growth rate of the bottom 40 percent is more likely that these are different goals, each with distinct devel- to occur in countries with declining inequalities, at opment challenges. least in our sample of countries. Sixty percent (31 of 52) of the countries with declining inequality were What do we know about shared prosperity in countries that saw a relatively faster (>4 percent per recent years? capita per annum) growth of the bottom 40 percent A number of salient points emerge from analyzing in comparison to 33 percent (9 out of 27) of the the growth rate of the bottom 40 percent. countries where inequality was increasing (figure 2). First, the growth rate of the bottom 40 percent is Finally, low- and lower-middle-income countries very highly correlated with average growth rates, sug- appear to have had less success in boosting shared gesting that overall income growth is necessary for prosperity than upper-middle and high-income shared prosperity. developing countries during this period. The growth Second, the median growth in real per capita in- rate of the bottom 40 percent in the median country come of the bottom 40 percent of the income dis- in the richer group was 5 percent, compared to 2.9 tribution in a country in the sample is 4.2 percent. percent for the low- and lower-middle-income group. This rate is fairly high compared to the median of This is fairly comparable to what is observed for the the annual growth in per capita income of the overall average growth rate as well: The median country in Inequality in Focus : : October 2013 : : 3 the richer group grew by 4.5 percent, compared to a proves welfare of those at the bottom is incompatible much slower rate of 2.6 percent for the poorer group with a long-term rise in inequality. This is supported of countries. This suggests a more nuanced view on indirectly by the fact that no country has transited the perception of convergence between the rich and beyond middle-income status while maintaining high poor countries: While there has been some conver- levels of inequality (Ferreira and Ravallion, 2009). This gence, other inequalities are being created as incomes is particularly true if there are deeply rooted structural within developing countries, particularly for the poor inequalities or inequality of opportunity for certain living there, are growing but at much slower rates social or economic groups (Easterly, 2007). than for their counterparts in wealthier nations. Inequality can catalyze socioeconomic development under some conditions; it can be a serious deterrent How can the shared prosperity indicator be useful in others. Yet increasing the incomes of the poor is a in guiding policies to improve the welfare of the valid development objective in all circumstances, at less well-off? all times, and at any stage of the development process The indicator itself is a simple monitoring device, or the economic cycle. While the question of whether while the policy agenda underpinning the idea of it should be pursued as the objective is something shared prosperity is much more complex than simply that should be evaluated for a particular country and raising incomes. The WBG policy goals of ending pov- a particular point in time, there seems to be enough erty and sharing prosperity take explicit aim at improv- evidence to suggest that countries looking to make ing not just the monetary, dimensions of welfare over durable progress on improving the welfare of the least time, but the nonmonetary dimensions as well. Some of well-off over the medium to long term should be these nonmonetary dimensions are education, health, mindful of the degree to which structural inequalities nutrition, and access to essential infrastructure. Em- exist in their economies. powerment and enhancing voice and participation in economic, social, and political spheres are also included What are some of the pathways to achieving among nonmonetary dimensions. Therefore, shared shared prosperity? prosperity is intended to do more than just improve Economic growth is of course fundamental. Eco- the incomes of the bottom 40 percent; it also aims to nomic growth can lead to broad-based prosperity if improve the many diverse dimensions of poverty and the growth pattern generates more and better quality well-being. jobs, higher earnings, and economic opportunities for all segments of the population. The World Development Should inequality reduction be an explicit goal in Report 2013 argues persuasively that jobs are also a boosting shared prosperity? transformative force—for example, jobs that empower While higher growth for the bottom 40 percent has women lead to greater investments in children, and gone hand in hand with reduction in inequality in efficiency increases as more productive jobs replace countries such as Brazil, Bolivia, and Cambodia, the less productive ones. In the decade of the 2000s, same cannot be said for many other countries like most of the reduction in poverty across the globe Egypt and the Philippines. As figure 2 shows, if the was related to better labor market engagement in the objective is to boost shared prosperity, then reduc- form of more and better-paying jobs; only to a lesser ing inequality in itself may be neither necessary nor extent did direct income transfers to the poor, remit- sufficient. This is not to say, however, that the same tances, or changes in demographic patterns contribute relationship holds true in the medium to long run (Inchauste, et al., 2012; Azevedo, et al., 2013). as well. In fact, there is a large body of evidence that Evidence also suggests that poverty reduction is establishes that economic progress that sustainably im- higher when growth is biased toward labor-intensive 4 : : October 2013 : : Inequality in Focus Figure 3 Pathways to Improve the Well-Being of the Poor opportunities for all, including women and youth, and provide safety nets to protect the vulnerable against extreme deprivation and shocks. The redistribu- tion of resources this implies is not just about transferring income from one segment of the society to another at a particular point in time, but more about investing in improving the capabilities of people over time and across generations, so people can improve their welfare on their own. Economic growth is a neces- sary condition, generating the resources needed for such investments, which would in turn contribute to higher and more sustainable growth in incomes over time. An effective social contract is about creating such a virtuous, self-sus- taining cycle—economic growth leading to higher human capabilities, which in turn feeds back to growth, and so on. What role does inequality sectors (Loayza and Raddatz, 2010). But for this to of opportunities play? occur, growth needs to be diversified and to generate In many countries, high inequality is a manifesta- employment opportunities in multiple sectors. While tion of a broken social contract with unequal dis- such a process of economic transformation is led by tribution of opportunities. This inequality in op- the private sector, the state needs to play a limited portunities systematically limits the life chances of but crucial role to improve competitiveness, promote individuals who draw an unlucky hand in the lottery investment climate, and encourage innovation in the of life, by being born of a certain gender, or race private sector. This includes providing a regulatory and ethnicity, or to parents of certain socioeconomic and macroeconomic environment that provides stabil- status, and so on. In these cases, closing the oppor- ity and the right incentives to the private sector, and tunity gaps in society, particularly among children, investing in public goods like physical infrastructure and ensuring that the human and productive poten- and in people to build a modern workforce. tial of every individual is maximized will be critical The second channel, in addition to jobs and the to achieving further poverty reduction and shared labor market, is that of a healthy and stable social prosperity. Childhood opportunities play a critical contract to ensure that growth includes the poorer role later in life, particularly in opportunities related segments of society. The country’s social contract to labor market participation, entrepreneurship, generates a specific structure of taxation and social having access to productive assets, financial services, expenditures, and social protection programs. A social markets, and infrastructure and being able to exercise contract for promoting shared prosperity must allow voice and agency in social and political spheres. for societal investments in institutions that improve A focus on equality of opportunity in the social Inequality in Focus : : October 2013 : : 5 Figure 4 Opportunities in School Attendance in sub-Saharan Africa and Latin America Source: Demographic and health surveys for different years (circa 2008), from World Bank (2013, forthcoming). contract is thus necessary to promote shared prosper- roughly an eighth of the likelihood for a boy born in an ity from the point of view of equity and growth alike. urban household in the highest wealth quintile with a Growing evidence suggests that improving access for all highly educated head (World Bank, forthcoming). and reducing inequality of opportunity is not just about Even for middle-income countries, where access to “fairness” and building a “just society,” important as basic goods and services is nearly universal, inequality these principles are, but also about realizing a society’s of opportunity is widely prevalent in access to early aspirations of economic prosperity. Notably, the divi- childhood inputs, quality schooling, health services, dends of investing in opportunities among children are and infrastructure. In Vietnam, for example, even likely to accumulate over time and across generations. though primary schooling is nearly universal, nearly 40 percent of children in Grade 5 exhibit inadequate How far from universal are basic opportunities for mathematics or language skill to progress to the lower children in developing countries? secondary level. These children are disproportion- There is a lot of work to be done on this front. A ately likely to belong to poorer households (bottom recent analysis for a report on sub-Saharan Africa two quintiles of wealth), belong to an ethnic minority, (World Bank, forthcoming) has found access to even live in rural areas, and have parents with low educa- the most basic goods and services (quality primary tion (primary school or less) (Vietnamese Academy of schooling, adequate sanitation, and the like) among Social Sciences and the World Bank, 2012). Similarly, children to be highly inadequate in almost all the in South Africa, completion of primary school on time countries studied. For example, the school attendance and exposure to early-childhood programs (among rate among 6- to 11-year-olds is less than 80 percent 0–4 year olds) are far less than universal and highly in 14 out of 20 countries for which the analysis was unequal, with most of the differences being associated done. In addition, these opportunities are also ineq- with socioeconomic background, location, and ethnic- uitably distributed among children of different house- ity of the children (World Bank, 2012). hold wealth, parental education level, urban/rural residency, and so on. In countries such as Cameroon, How do opportunities during childhood matter for Nigeria, and Rwanda, the likelihood of complet- growth and poverty reduction? ing primary school on time for a girl born in a rural These early disadvantages are often compounded in household in the lowest quintile of wealth, where the the labor market, and disadvantages early in life trans- household head has education below primary level, is late into restricted employment opportunities when 6 : : October 2013 : : Inequality in Focus 50 Figure 5 Proportion of Total Inequality Attributable to Inequality of Opportunity 40 30 20 10 0 Greece France Ghana Norway Latvia UK Belgium Estonia Slovenia Lithuania Poland Finland Czech Rep Italy Germany Slovakia Hungary India-Urban India-Rural Portugal Spain Ireland Netherlands Denmark Austria Egypt Sweden Ivory Coast Colombia Madagascar Panama Guinea Brazil Ecuador Peru Guatemala Note: The plotted values are between group shares of total inequality measured by the mean-log deviation (Theil-L). Theil-T is used in the cases of Ghana, Guinea, Ivory Coast, and Madagascar. Source: Based on data from Ferreira and Gignoux (2011). children become young adults. In South Africa, for The equality of opportunity lens gives us a view of example, an overall unemployment rate of 25 percent in the “less well-off” that is broader and more textured 2012 is exacerbated by large differences in employment than the bottom 40 percent of the income distribu- rates among workers with different characteristics. Even tion. It could imply, for example, extending the con- after accounting for the effects of education and experi- cept of “bottom 40 percent” to include access to basic ence (age) of workers, circumstances at birth contribute goods and services, or opportunities, among children. almost half of the inequality among groups: Being a In other words, the relevant population of interest resident of an urban township or village, a woman or would be not so much the poorest two-fifths of soci- of non-white ethnicity is associated with a much higher ety—although that remains critically important—but likelihood of being unemployed or underemployed the most “opportunity-deprived.” The additional focus (World Bank, 2012). These disadvantages then manifest that the equity lens brings will ensure that any policy themselves in income inequality and other outcomes. A designed to address shared prosperity will also ad- recent paper reports that in countries such as Brazil and dress other dimensions of disparity such as parental Guatemala, up to a third of the total inequality in earn- education, region, urban/rural residence, gender, race/ ings could be attributed to inequality of opportunity ethnicity, and so on. Additionally, targeting policies to- (Ferreira and Gignoux, 2011). ward a group defined by low opportunity (as opposed to low income) broadens the concept of shared pros- Finally, from an analytical as well as policy point of perity to take into account a more multidimensional view, how can a lens of equality of opportunity be view of welfare that includes education, health, and useful for shared prosperity? infrastructure services. Inequality in Focus : : October 2013 : : 7 References tion of Growth Matters for Poverty Alleviation.” Jour- Azevedo, J., G. Inchauste, S. Olivieri, J. Saavedra, nal of Development Economics, 93(1). and H. Winkler. 2013. “Is Labor Income Responsible Saavedra, J., and M. Tommasi. 2007. “Informality, for Poverty Reduction? A Decomposition Approach.” the State and the Social Contract in Latin America: A Policy Research Working Paper 6441. The World Preliminary Exploration.” International Labour Review, Bank. 146: 279–309. Berg, A., J. Ostry and J. Zettelmeyer. 2012. “What Vietnamese Academy of Social Sciences and the makes growth sustained?” Journal of Development Eco- World Bank. 2012. “Opportunities of Children in nomics, 98(2). Vietnam.” Easterly, W., 2007. “Inequality does cause underde- World Bank. 2012. South Africa Economic Update: velopment: insights from a new instrument.” Journal of Focus on Inequality of Opportunity. July 2012. Report Development Economics, 84(2). number 71553. Ferreira, F., and J. Gignoux. 2011. “The Measure- World Bank. 2013. “The World Bank Group Goals: ment of Inequality of Opportunity: Theory and Appli- End Extreme Poverty and Promote Shared Prosperity,” cation to Latin America.” Review of Income and Wealth Washington, DC. http://www.worldbank.org/content/ 57(4): 622-657. dam/Worldbank/document/WB-goals2013.pdf. Ferreira, F., and M. Ravallion. 2009. “Poverty and Inequality: the Global Context” in W. Salverda, et al. Narayan, A., J. Saavedra-Chanduvi, and S. Tiwari. “The Oxford Handbook of Economic Inequality.” Ox- Forthcoming 2013. “Shared Prosperity: Links to ford University Press. Growth, Inequality, and Equality of Opportunity.” The Inchauste, G., J. Azevedo, S. Olivieri, J. Saavedra, World Bank PREM Network, Washington, DC. and H. Winkler. 2012. “When Job Earnings Are Be- World Bank. Forthcoming. Do African Children Have hind Poverty Reduction.” Economic Premise, 97. The an Equal Chance? A Human Opportunity Report for World Bank. Twenty Countries in sub-Saharan Africa. Washington, Loayza, N., and C. Raddatz. 2010. “The Composi- DC. 8 : : October 2013 : : Inequality in Focus Managing Risk Is Essential to Reducing Poverty and Inequality Excerpts from the 2014 World Development Report O ver the past three decades, the world’s The newly published poverty levels have declined. Perpetu- 2014 World Develop- ally impoverished countries like China, ment Report focuses on India, and Brazil are now emerging the theme of managing global powers. Within these countries risk for development. and a host of others, the populations of those living in It argues that not only extreme poverty have diminished significantly. Along can better risk manage- with the decline in poverty have come improvements in ment avert loss of life, costly damages, and setbacks, equity. Brazil and other countries known for high levels but it can also unleash opportunity for growth and of economic inequality have made marked improve- advancement. Although the purpose of the 2014 WDR ments in these metrics. As the world changes, a host of was not to analyze the impacts of risk management, or opportunities arise. With them, however, old and new lack thereof, on inequality, there are nevertheless many risks appear, from the possibility of job loss and disease impacts and solutions that emerge. This article compris- to the potential for social unrest and environmental es modified excerpts from the report, as well as some damage. If ignored, these risks can turn into crises that unpublished material provided by the WDR team. reverse hard-won gains and endanger the social and Shocks can exacerbate inequality economic reforms that produced them. Furthermore, by more negatively affecting the poor such risks, if not managed correctly, can play a signifi- Risk and shocks do not affect all people in the same cant role in keeping or pushing people into poverty way, and can have the consequence of exacerbating and exacerbating inequality, especially because the poor inequality. Households that are better off or that have tend to be hardest hit by negative shocks and have the access to strong risk management tools are typically fewest resources to prepare for them (Baulch, 2011; able to take on more risk, and therefore can expect Narayan, Pritchett, and Kapoor, 2009). The solution is higher returns (Carter, et al., 2007). Poor households, not to reject the changes that bring about opportuni- by contrast, are often compelled to avoid risk because ties along with risks, but to prepare for them. Manag- they fear the potential for negative outcomes. Realizing ing risks responsibly and effectively has the potential to that a negative shock can push them into destitution, bring about security and means of progress to people in bankruptcy, or crisis, poor people may stick with tech- developing countries and beyond. nologies and livelihoods that appear relatively safe but are also stagnant. This article comprises excerpts from the 2014 World Develop- ment Report, written by the 2014 WDR team. The team includes Other risks, such as those stemming from economic Norman Loayza (director), Inci Otker-Robe (deputy director), crisis or crime, are “imposed” and do not reflect op- Rasmus Heltberg, Ana Maria Oviedo, Xubei Luo, Martin Melecky, portunities. Several of the “imposed” risks and hazards Stéphane Hallegatte, César Calderón, and Kyla Wethli. The full affect the poor disproportionately—either because they World Development Report 2014 can be downloaded at www. worldbank.org/wdr2014. Mr. Loayza, Mr. Helberg, Ms. Oviedo, and have higher exposure than those who are better off, lose Ms. Wethli provided helpful suggestions for this article, which was a larger share of their wealth in shocks, are less able to compiled, arranged, and modified by Maximillian Ashwill. afford protection and insurance to prepare for risks, Inequality in Focus : : October 2013 : : 9 lack access to important markets and public services, or suffer from social exclusion. As a result, when hit by a shock, the poor are far more likely to rely on adverse coping responses that can negatively affect their long- term prospects, such as reducing food consumption or taking children out of school (Ashwill and Heltberg, 2013). An overarching conclusion that emerges is that many people, and not just the poor, are exposed and vulnerable to risk and that although many people are able to escape poverty every year, many others fall into poverty because of shocks and a lack of protection. Alongside systemic risks, such as economic crises and natural disasters, idiosyncratic risks, which are specific Arne Hoel/World Bank to individuals or households, are equally important for people’s welfare. Losing a job or not finding one because poorest are the least insured. For example, in rural China, of inadequate skills, falling victim to disease or crime, for the poorest tenth of the population, a loss of income of or suffering a family breakup from financial strain or 100 yuan led people to cut food and other expenditures forced migration can be overwhelming, particularly by 40 yuan, while for the richest third of households, for vulnerable families and individuals. Households in the same shock resulted in a consumption cut of only 10 Ethiopia whose members experienced serious illness, yuan (Jalan and Ravallion, 1999). for example, were forced to cut their consumption by Whether adverse consequences come from systemic almost 10 percent, and they continued to be negatively or idiosyncratic risks, they may destroy lives, assets, affected three to five years later (Dercon, Hoddinott, trust, and social stability. And it is often the poor who and Woldehanna, 2005). Health costs from high levels are hit the hardest. Despite impressive progress in of crime and violence amount to 0.3–5.0 percent of reducing poverty in the past three decades, a substan- gross domestic product (GDP) a year for countries in tial proportion of people in developing countries are Latin America, without even considering the impact of vulnerable to falling into poverty when they are hit crime on lost output because of reduced investment and by negative shocks (figure 1). The mortality rate from labor participation (Buvinic and Morrison, 2000). Loss illness and injury for adults under age 60 is two-and- of employment in countries as different as Argentina, a-half times higher for men and four times higher for Bulgaria, and Guyana has not only lowered income and women in low-income countries than in high-income consumption but has also reduced people’s ability to countries, while the rate for children under age five is find new work, worsened social cohesion, and in some almost 20 times higher (WHO, 2013). There is grow- cases increased domestic violence (World Bank, 2012). ing evidence that adverse shocks—above all, health Community-based insurance provides people with and weather shocks and economic crises—play a major partial compensation for the impact of shocks, but many role in pushing households below the poverty line and shocks nevertheless cause serious hardship, especially for keeping them there (Baulch, 2011). the poor. Studies of households that face income shocks show that their consumption falls less than income: In Risk management can unleash opportunity other words, some risk is insured away and some is re- Yes, risk is a burden, but it is also necessary to the tained (Fafchamps and De Weerdt, 2011; Morduch, 2002; pursuit of opportunity. Risk and opportunity go hand in Ravallion and Chaudhuri, 1997; Townsend, 1994). The hand in most decisions and actions taken by countries, 10 : : October 2013 : : Inequality in Focus Figure Figure 11Many people around the world live very close to poverty, and are vulnerable to entering into poverty people Many they when are hit bythe around live very close to poverty, and are vulnerable to entering into poverty world shocks negative when they are hit by negative shocks. More than 20a. All developing percent countries, of the population b. 2010 countries live on in developing Developing less than $1.25 acountries in selected day, more than regions, 50 percent 2010 on less than $2.50, and nearly 75 percent on less than $4. total population, in millions percent of population in each region a. All developing countries, 2010 b. Developing countries in selected regions, 2010 total population, in millions percent of population in each region 500 $1.25 per day 16 $1.25 per day SSA 14 SAR $2.5 per day $2.5 per day 400 EAP 12 10 MENA 300 LAC 8 200 ECA 6 4 100 2 0 0 $0 $2 $4 $6 $8 $10 $12 $14 $0 $2 $4 $6 $8 $10 $12 $14 Source: WDR 2014 team based on data from PovcalNet. Note: $1.25 per day is a widely used measure of extreme poverty. However, $2.50 per day is considered a more relevant measure Source : WDR 2014 team based on data from PovcalNet. ! poverty for some regions, such as Latin America and the Caribbean. See Ferreira and others, 2013. of extreme Note: $1.25 per day is a widely used measure of extreme poverty. However, $2.5 per day is considered a more enterprises, relevant and measure families of extremein the process poverty of regions, for some development. to undertake such as Latin America andnew and promising, the Caribbean. but risky, and ventures. See Ferreira Consider a others 2013. few examples. Since the 1990s, most de- Some farmers in Ethiopia, for instance, choose not to veloping countries have opened their borders to seek use fertilizer because they fear drought and other poten- international integration and higher economic growth, tial shocks, and thus prefer to retain savings as a cush- but in the process have also increased their exposure ion rather than investing in intermediate inputs (Dercon to international shocks. Firms around the world have and Christiaensen, 2011). In contrast, farmers in Ghana made investments to upgrade their technologies and and India who have access to rainfall insurance have increase profitability, but the debt required to do so has been less reluctant to taking on risk in search of higher made them more vulnerable to changes in demand and yields—switching to higher-return but more sensitive credit conditions. From Brazil to South Africa, millions cash crops, and increasing their investments in fertilizer, of families have migrated to cities to seek better job op- seeds, pesticides, and other inputs (Karlan, at al., 2012, portunities and health and education services, but have for Ghana; and Cole, et al., 2013, for India). also become more exposed to higher crime even as they Much of the emerging literature on risk in a devel- have less communal support. The motivation behind opment context emphasizes the important role that these actions is the quest for improvement, but risk aris- risk management can play in increasing resilience es because favorable outcomes are seldom guaranteed. to negative shocks. However, to increase prosperity Risk management is the process of confronting risks, and well-being, risk management also has an essen- preparing for them, and coping with their effects. Hav- tial role in helping people and countries successfully ing risk management tools—such as improved infor- manage positive shocks. Indeed, successfully man- mation, crop insurance, and employment diversifica- aging positive shocks is a critical part of increasing tion—can help people mitigate risk. In turn, this can people’s resilience to negative shocks over time. For allow people, especially the poor, to be more willing example, a farmer’s ability to withstand a drought Inequality in Focus : : October 2013 : : 11 may be substantially influenced by Box 1 How Does Preparation for Risk Vary Across Countries? Box 1 How does preparation for risk vary across countries? how the yields from years of good Extent of risk preparation around Extent the of risk world. around the world preparation rainfall were managed. Thus the goal of risk management is to both decrease the losses and increase the benefits that people experience when they face and take on risk. Overall, preparation for risk tends to be cor- related with income across countries, although interesting variations within regions highlight the important role of policy in determining preparation for risk (box 1). Least prepared quintile Second Third Fourth Most prepared quintile Missing data Low-income countries The map shows an index of preparation for risk, developed for the World Development are improving index 2014. Report An The index of preparation comprises for risk, developed measures of assets for the World and services Development that Report 2014 , is influence prepara- charted on the map above. their ability to manage risk The tion index comprises for risk. measures of assets The component and services indicators that influence for the preparation index include: for risk. average The component years indicators of schooling, for and the theindex include: average immunization rateyears of schooling, for measles and the (human immunization capital); rate for measles the proportion (human capital); of households with the Developing countries have made sub- proportion of households with less than $1,000 in net assets, and an index of access to finance (physical and less than $1,000 in net assets, and an index of access to finance (physical and financial as- financial assets); the percent of the workforce who contribute to a pension scheme, and the proportion of stantial improvements in some aspects sets); the percent of the workforce who contribute to a pension scheme, and the propor- respondents stating that “in general, people can be trusted” (social support); and the percent of the population with of their risk management in recent tion of access to respondents stating improved sanitation that and facilities, “in gross general, people public debt as can be trusted” a percentage (social of revenues support); (state and support). the percent of the population with access to improved sanitation facilities, and gross public decades. The percentage of people in This index shows that the extent of households’ preparation for risk tends to be correlated with national income debt as a percentage of revenues (state support). across countries. Households tend to be the most prepared in high-income countries (particularly in North America low- and middle-income countries and western Europe), and least prepared in low-income countries (especially in Africa), on average, However, with access to improved sanitation, for This index substantial shows variation thatwithin exists regions.of households’ preparation for risk tends to be correlated the extent with national income across countries. Households tend to be the most prepared in high- instance, has increased from 36 per- Source: Foa 2013 for the WDR 2014. Map number: IBRD 40097. income countries (particularly in North America and western Europe), and least prepared cent in 1990 to 56 percent in 2010; in low-income countries (especially in Africa). On average, however, substantial variation meanwhile, the immunization rate for exists within regions and across countries with similar GDP per capita, highlighting the importance of policies, over and above access to resources, in determining preparation for measles doubled from 41 percent to risk. 83 percent between 1985 and 2010 Source: Foa 2013 for the WDR 2014. Map number IBRD 40097. (World Development Indicators). Im- proved sanitation and increased vac- cination, along with other preventive health measures, to them. Farmers in Ghana and 15 other African coun- have helped reduce infant and maternal mortality rates. tries, for example, receive specific market information Similarly, following repeated cycles of high inflation through their mobile phones, which helps them to during the 1970s and 1980s, many middle-income improve their response to changes in agricultural prices countries developed sound fiscal and monetary policy and demand (Khokhar, 2013). frameworks, which have helped reduce the incidence of Several factors limit people’s ability economic shocks. to manage risk While knowledge of risks often has been lacking in If risk management can save lives, avert economic developing countries, it is increasing in several key damages, and unleash opportunity—and, furthermore, areas, such as dealing with disease and natural hazards. if risk management is cost-effective and its fundamen- And new technologies are greatly helping to improve tals are well understood—then, why aren’t people and knowledge of potential shocks and inform responses societies better at managing risk? Although the specific 12 : : October 2013 : : Inequality in Focus and this process seems to be well understood (Gourinchas and Obstfeld, 2012; Schul- arick and Taylor, 2012). Yet policy makers often do little to control credit booms. A false sense of security may underlie people’s inability to manage preparation for risk in normal times (by saving for a rainy day or completing disaster preparedness plans, for instance). And a “paradox of protection” can arise: Risk protection that suppresses losses for a long period cre- ates a false sense of security, leading to decreased vigi- Amir Jina/UN ISDR lance and risk awareness and potentially resulting in larger reason varies from case to case, it is always related to the future losses (Hallegatte, 2012). obstacles and constraints from which individuals and There are also obstacles to risk management beyond societies suffer. These constraints include: the control of individuals. First, there may be missing • A lack of resources: Even when a risk management markets and public goods. Markets in areas critical for strategy is cost-effective, individuals and groups may effective risk management—credit, insurance, jobs—are find it difficult to undertake because of large upfront weak or even missing in many developing countries. So costs and limited access to credit. Shortages of assets are public goods and services essential for risk manage- and finance, especially acute in poor and developing ment—economic and political stability, law and order, countries, can make the trade-offs inherent in risk and basic infrastructure. In fact, well-developed markets management harder to handle. may be missing because supportive public goods are • A lack of information or cognitive failures: Rel- flawed. If, for instance, contracts are not enforced by evant information may not exist or be available to the justice system, it makes little sense to buy health, decision makers, or they may lack the ability to vehicular, or house insurance, and no such market will understand this information. exist (La Porta, et al., 1998). There are a large num- • Behavioral failures: Even if information exists, de- ber of reasons as to why public goods are missing, but cision makers may be unable to turn knowledge consider only the most pertinent ones for risk manage- into actions and behaviors that prepare them for ment. The first, lack of resources, has been mentioned. risk. In many cases, decision and policy makers Another problem is related to the political economy of seem to have short memories regarding the ori- risk management: Governments may be reluctant to gins of crises of various sorts. Systemic financial spend on risk preparation because its costs are immedi- crises, for instance, are almost always preceded by ate and observable while its benefits, even if substantial, unusually high credit concentration and growth, are longer term and less visible. Inequality in Focus : : October 2013 : : 13 Second, there may be government failures or other pooling resources, and diversifying risks. political economy issues, including corruption and • Communities provide informal networks of insur- distortionary policies. One example is policy capture, ance and protection, helping people deal with id- when government policy favors the interests of particu- iosyncratic risks and pooling resources to confront lar constituencies. Firms and people that are negatively common risks. affected by risk management will naturally tend to • Enterprises can help absorb shocks and exploit oppose any constraint and be vocal about it, while the the opportunity side of risk, contributing to stable people protected by prospective regulation are often not employment, growing income, and greater inno- aware of it and therefore do not support it, or lack the vation and productivity. commensurate influence of powerful lobbies. Some- • The financial system can facilitate useful risk man- times well-intentioned policies can impair risk manage- agement tools such as savings, insurance, and ment by distorting people’s incentives to manage their credit, while managing its own risks responsibly. own risk. An example is the creation of ill-designed • The state has the scale and tools to manage sys- post-disaster support that creates moral hazard and temic risks at the national and regional levels, to discourages risk management by individuals and firms. provide an enabling environment for the other Similarly, overly generous safety nets or financial sector systems to function, and to procure direct support bailouts can undermine risk management incentives. to vulnerable people. Third, social and economic externalities may present »» It can provide social protection (social insur- risk management obstacles. Risk management actions ance and assistance), public goods (national undertaken by some people may impose losses on oth- defense, infrastructure, law and order), and ers. For instance, overuse of antibiotics is creating ever public policy (sound regulation, economic more drug-resistant bacteria. Other risk management management). actions can actually generate benefits for people other »» Through macroeconomic policy, the state than those bearing their cost. This is the case, for in- can help maintain economic stability and stance, for countries that take costly measures to reduce ensure funding of public services and infra- greenhouse emissions, which can benefit the rest of structure. the world. Both negative and positive externalities may • The international community can offer expertise, complicate the process of risk management, making it facilitate international policy coordination, and less predictable and distorting the incentives for action. pooling of resources when risks exceed national Conclusion: Shared risk management can capacity or cross national boundaries. unleash opportunity and reduce inequality People can successfully confront risks that are beyond References their means by sharing their risk management with oth- Ashwill, Maximillian, and Rasmus Heltberg. 2013. ers. They can pool their risk collectively through various “Is There a Community-Level Adaptation Deficit?” overlapping social and economic groupings (systems). Background paper for the World Development Report These systems extend in size and complexity—from the 2014. household to the international community. They have the potential to support people’s risk management in Baulch, Bob. 2011. Why Poverty Persists: Poverty Dy- different yet complementary ways. Their different scope namics in Asia and Africa. Cheltenham, U.K.: Edward may allow them to handle shocks and exposures that Elgar. match their scale. Buvini´c, Mayra, and Andrew R. Morrison. 2000. “Liv- • The household is the primary instance of support, ing in a More Violent World.” Foreign Policy (118): protecting its members (especially the vulnerable), 58–72. 14 : : October 2013 : : Inequality in Focus Carter, Michael R., Peter D. Little, Tewodaj Mogues, sions after Relaxing Credit and Risk Constraints.” and Workneh Negatu. 2007. “Poverty Traps and Working Paper 18463, National Bureau of Econom- Natural Disasters in Ethiopia and Honduras.” World ic Research, Cambridge, MA. Development 35 (5): 835–56. Khokhar, Tariq. 2013. “Leveraging New Technology Cole, Shawn, Xavier Giné, and James Vickery. 2013. for Data-Driven Risk Mitigation and Management: “How Does Risk Management Influence Produc- Selected Examples and Summaries.” Background tion Decisions? Evidence from a Field Experiment.” paper for the World Development Report 2014. Working Paper 13–080, Harvard Business School, La Porta, Rafael, Florencio Lopez de Silanes, An- Boston, MA. drei Shleifer, and Robert W. Vishny. 1998. “Law Dercon, Stefan, and Luc J. Christiaensen. 2011. “Con- and Finance.” Journal of Political Economy 106 (6): sumption Risk, Technology Adoption and Poverty 1113–55. Traps: Evidence from Ethiopia.” Journal of Develop- Morduch, Jonathan. 2002. “Consumption Smoothing ment Economics 96 (2): 159–73. across Space: Testing Theories of Risk-Sharing in the Dercon, Stefan, John Hoddinott, and Tassew Wolde- Icrisat Study Region of South India.” United Nations hanna. 2005. “Shocks and Consumption in 15 University Wider Discussion Paper 55, United Na- Ethiopian Villages, 1999–2004.” Journal of African tions University–World Institute for Development Economies 14 (4): 559–85. Economics Research, Tokyo. Fafchamps, Marcel, and Joachim De Weerdt. 2011. Narayan, Deepa, Lant Pritchett, and Soumya Kapoor. “Social Identity and the Formation of Health Insur- 2009. Moving Out of Poverty: Success from the Bottom ance Networks.” Journal of Development Studies 47 Up, Vol. 2. Washington, DC: World Bank. (8): 1152–77. Ravallion, Martin, and Shubham Chaudhuri. 1997. Foa, Roberto. 2013. “Household Risk Preparation In- “Risk and Insurance in Village India: Comment.” dices—Construction and Diagnostics.” Background Econometrica: Journal of the Econometric Society 65 paper for the World Development Report 2014. (1): 171–84. Gourinchas, Pierre-Olivier, and Maurice Obstfeld. Schularick, Moritz, and Alan M. Taylor. 2012. “Credit 2012. “Stories of the Twentieth Century for the Booms Gone Bust: Monetary Policy, Leverage Twenty-First.” American Economic Journal: Macroeco- Cycles, and Financial Crises, 1870–2008.” American nomics 4 (1): 226–65. Economic Review 102 (2): 1029–61. Hallegatte, Stéphane. 2012. “An Exploration of the Townsend, Robert M. 1994. “Risk and Insurance in Link between Development, Economic Growth, and Village India.” Econometrica: Journal of the Economet- Natural Risk.” Policy Research Working Paper 6216, ric Society 62 (3): 539–91. World Bank, Washington, DC. WHO (World Health Organization). 2013. World Jalan, Jyotsna, and Martin Ravallion. 1999. “Income Health Statistics 2013. Geneva: WHO. Gains to the Poor from Workfare: Estimates for Ar- World Bank. 2012.World Development Report 2013: gentina’s Trabajar Program.” Policy Research Work- Jobs. Washington, DC: World Bank. ing Paper 2149, World Bank, Washington, DC. World Bank. 2013. World Development Report 2014: Karlan, Dean, Robert Darko Osei, Isaac Osei-Akoto, Risk and Opportunity—Managing Risk for Develop- and Christopher Udry. 2012. “Agricultural Deci- ment. Washington, DC: World Bank. Inequality in Focus : : October 2013 : : 15 The Inequality in Focus series aims at informing the public debate on equity, in- equality of opportunity, and socioeconomic mobility. It features articles written by World Bank staff, as well as researchers and policy makers from the broad devel- opment community. The views and interpretations in the articles are those of the authors and do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent. The Inequality in Focus series is not copyrighted and may be reproduced with appropriate source attribution. Editorial Committee: Pedro Olinto (managing editor), Maximillian Ashwill (senior editor), Jaime Saavedra, Francisco Ferreira, Luis-Felipe Lopez-Calva, John Newman, Gabriel Demombynes, and Anna Reva Editor: Mary Anne Mulligan THE WORLD BANK Poverty Reduction and Equity Department Poverty Reduction and Economic Management Network (PREM)