ISET

ISET Economist Blog

A blog about economics in the South Caucasus.

Redistribution Versus Growth: Georgia at the Crossroads

One day in my village, I saw our neighbors carrying TV sets, refrigerators, parabolic antennas, and washing machines out of their house. Soon I found out that they were hiding all that stuff from the Social Service Agency (SSA) that was about to check eligibility for social benefits. Later, when I spoke with some other villagers, it turned out that some families had even sold their cows to become eligible for social assistance. “Cows are costly and do not give income on a permanent basis”, they said. Others avoided work contracts because official employment would make them lose their low but reliable welfare payments.

Readers not familiar with the Georgian welfare system may wonder why it is necessary to hide valuable objects if one wants to receive social benefits. When somebody applies for social assistance in Georgia, the government will send inspectors who assess the overall economic situation of the household. The availability of consumer electronics, household devices, and other expensive items make it less likely that support is granted. You better hide your flatscreen TV when the auditors come!

It may still be surprising that the humble amounts paid by the Georgian welfare system really give incentives to resort to such tricks. If assistance is granted, the oldest member of a family receives 60 lari per month, and each further member receives 48 lari. A standard family with two children thus receives 204 lari. Given the low income level, this is serious money for many Georgian families, and it can (illegally) be received in addition to other income, as long as that other income is not received through formal employment.

june9-2014-1

Incentive distortions, however, are not the only problem associated with a social welfare system.


IS IT THE RIGHT TIME TO REDISTRIBUTE?

In the graph, which is based on data provided by the ministry of finance, the bars show the evolution of the government of Georgia’s budget composition from 2010 to 2014 (values for 2014 are estimated). One can see that compared to the previous government led by the United National Movement (UNM), running the country until 2012, the new government significantly increased the expenditure on social benefits. The line with triangles shows the percentage change of the total budget over those years, and the line with circles shows how the growth of the welfare budget contributed to the change of the total budget (in percentage points).

The state pension fund, the pecuniary social assistance (subsistence allowance), the universal health care program, and the new minimal tax refund policy are among the measures that were introduced or upgraded by the new Georgian government, aiming at improving the economic situation of low income and poor families. These redistributive policies are sharply criticized by the opposition.

According to UNM politicians, Georgia’s stage of development does not allow for a substantial welfare state. They claim that redistribution only makes sense if there is something to be redistributed, and if the gross domestic product (GDP) is as low as in Georgia, the focus should be on stimulating growth. Moreover, a low GDP implies a small and fragile tax base, and – as it happened in many countries around the world – in such a situation social welfare can become “budgetary dynamite”, as welfare payments usually go up exactly when the tax base shrinks (i.e. in a recession).


THE ASIAN APPROACH

The UNM arguments are more or less consistent with the Nobel Prize-winning theories of the Belorussian economist Simon Kuznets (1901-1985) on the relationship between inequality and growth. According to Kuznets, when a country starts its economic development, economic growth is almost inevitably causing high inequality. The reason is that in very poor societies almost everybody is poor, and hence there is not much inequality. When economic development picks up, there are opportunities to become rich, but these opportunities are in the beginning only available to a few people in the society.

However, when a country develops further, at some point Kuznets expects inequality to decrease again. The reason is that comprehensive economic development yields opportunities for almost everybody in the society, giving everybody the chance to improve one’s economic situation.

Many Asian countries, like South Korea, Hong Kong, Taiwan, and Singapore, seem to support this theory. To this day, these countries lag behind other developing regions, like Latin America and the Caribbean, in their redistributive efforts. The Asian Development Bank’s Outlook 2014 highlights that the fastest developing Asian countries tended to use almost all of their fiscal resources for public investments rather than for income redistribution. According to the report, and in line with Kuznets’ predictions, the rapid economic growth over the past years reduced poverty in Asia. However, income gaps are not yet shrinking in most of these countries, suggesting that the tipping point of Kuznet’s theory, where inequality starts to decrease, has not been reached yet. But very recently, several Asian governments seem to start changing their priorities.  For instance, Thailand and India started to subsidize rice farmers, Korea upgraded its public pension system, and China introduced a concept termed Harmonious Society.

Should Georgia head the Asian way and give priority to growth over redistribution?

Every economic policy, if it is to be accepted by the population, must be compatible with the underlying values of a society. Perhaps, Georgian values too “European” to adopt Asian recipes. Moreover, the choice that has to be made may not be as clear-cut as it was presented so far. There is at least one example of a country that grew despite considerable welfare spending (Poland). And there are concepts that seem to resolve the contradiction between growth and redistribution. All of this will be discussed in next week’s continuation of this article.

Rate this blog entry:
8 Comments

Related Posts

Comments

 
Guest - Eric Livny on Monday, 09 June 2014 13:55

Here is what we wrote about two years ago on exactly the same subject (http://www.iset.ge/blog/?p=1171):

"there are case studies showing that Kuznets’ relationship does not always hold. One such example is related to the East Asian Miracle, when eight East Asian countries including Four Asian Tigers (South Korea, Hong Kong, Taiwan and Singapore) saw rapid growth in the period 1965-1990 without an increase in inequality, instead, poverty and inequality levels reduced during this high-growth period.

In his paper “Some Lessons from the East Asian Miracle” Jozeph Stiglitz argues that the main reason why these countries managed to successfully “break” the Kuznets curve was their governments’ “right” intervention at both the start and in the later stages of development. In particular, Stiglitz considers (i) agricultural reforms (resulting in higher rural productivity, income and, thus, savings), (ii) educational reforms (providing universal literacy) and (iii) redistribution policies, to be the key factors elevating inequality in the East Asian countries. All these reforms, as Stiglitz argues, further accelerated growth through mitigating socio-political instability and thereby encouraging investments."

I have a hard time reconciling the above with what you write here: "The Asian Development Bank’s Outlook 2014 highlights that the fastest developing Asian countries tended to use almost all of their fiscal resources for public investments rather than for income redistribution. According to the report, and in line with Kuznets’ predictions, the rapid economic growth over the past years reduced poverty in Asia. "

Which period is the ADB report referring to?

Here is what we wrote about two years ago on exactly the same subject (http://www.iset.ge/blog/?p=1171): "there are case studies showing that Kuznets’ relationship does not always hold. One such example is related to the East Asian Miracle, when eight East Asian countries including Four Asian Tigers (South Korea, Hong Kong, Taiwan and Singapore) saw rapid growth in the period 1965-1990 without an increase in inequality, instead, poverty and inequality levels reduced during this high-growth period. In his paper “Some Lessons from the East Asian Miracle” Jozeph Stiglitz argues that the main reason why these countries managed to successfully “break” the Kuznets curve was their governments’ “right” intervention at both the start and in the later stages of development. In particular, Stiglitz considers (i) agricultural reforms (resulting in higher rural productivity, income and, thus, savings), (ii) educational reforms (providing universal literacy) and (iii) redistribution policies, to be the key factors elevating inequality in the East Asian countries. All these reforms, as Stiglitz argues, further accelerated growth through mitigating socio-political instability and thereby encouraging investments." I have a hard time reconciling the above with what you write here: "The Asian Development Bank’s Outlook 2014 highlights that the fastest developing Asian countries tended to use almost all of their fiscal resources for public investments rather than for income redistribution. According to the report, and in line with Kuznets’ predictions, the rapid economic growth over the past years reduced poverty in Asia. " Which period is the ADB report referring to?
Guest - Florian Biermann on Tuesday, 10 June 2014 14:35

Eric, two different economists wrote on the same subject. Of course, they must come to different conclusions -- otherwise, this would not be serious economics. It is indeed surprising that there are only two views on this subject expressed in these two articles. More experienced economists would have come up with three or more...

Eric, two different economists wrote on the same subject. Of course, they must come to different conclusions -- otherwise, this would not be serious economics. It is indeed surprising that there are only two views on this subject expressed in these two articles. More experienced economists would have come up with three or more...
Guest - RT on Monday, 09 June 2014 15:46

it's probably -- just a bit -- misleading to call Kuznets "a Belorussian economist" :-)

it's probably -- just a bit -- misleading to call Kuznets "a Belorussian economist" :-)
Guest - NP on Monday, 09 June 2014 22:39

Eric has made a very good point. What is the time frame of the report? The evidence about the Asian countries shows, if something, the opposite [it is sufficient to check WDI data]. They achieved (impressive) development while educating their population and reducing inequality.

Eric has made a very good point. What is the time frame of the report? The evidence about the Asian countries shows, if something, the opposite [it is sufficient to check WDI data]. They achieved (impressive) development while educating their population and reducing inequality.
Guest - Simon Appleby on Tuesday, 10 June 2014 00:31

The most sustainable method of redistributing wealth from the rich to the poor is via a private sector job, not via taxpayer-funded income support.

The governments of the Asian Tigers provided subsidised public housing, health care and cheap education to the masses, because if they did not, they would have had to permit extraordinary wage inflation that would have crippled industry, or Communist revolutions in the 1960's and 70's against their governments. They always viewed this level of subsidy as a temporary solution for most families, lasting no more than one generation until families could provide for their own needs. The Confucian societies of Asia (China/Taiwan/Hong Kong/Japan/Korea/Vietnam) have always instilled their people with a revulsion for relying on handouts; many people would rather commit suicide when in difficulty rather than approach the government for assistance. In Hong Kong, all citizens over 60 are eligible for "fruit money" (a form of social welfare) but most refuse to register for it.

I can attest to the fact that, in Georgia, if my farming company demands that all workers sign formal labour contracts (to provide them with the mandatory insurance coverage in case of injury or death at work), most will refuse as it imperils their tiny benefit payments from the State. They would rather forgo GEL200-400 a month from casual labour than sacrifice GEL 60-80 in labour-free benefits.

The most sustainable method of redistributing wealth from the rich to the poor is via a private sector job, not via taxpayer-funded income support. The governments of the Asian Tigers provided subsidised public housing, health care and cheap education to the masses, because if they did not, they would have had to permit extraordinary wage inflation that would have crippled industry, or Communist revolutions in the 1960's and 70's against their governments. They always viewed this level of subsidy as a temporary solution for most families, lasting no more than one generation until families could provide for their own needs. The Confucian societies of Asia (China/Taiwan/Hong Kong/Japan/Korea/Vietnam) have always instilled their people with a revulsion for relying on handouts; many people would rather commit suicide when in difficulty rather than approach the government for assistance. In Hong Kong, all citizens over 60 are eligible for "fruit money" (a form of social welfare) but most refuse to register for it. I can attest to the fact that, in Georgia, if my farming company demands that all workers sign formal labour contracts (to provide them with the mandatory insurance coverage in case of injury or death at work), most will refuse as it imperils their tiny benefit payments from the State. They would rather forgo GEL200-400 a month from casual labour than sacrifice GEL 60-80 in labour-free benefits.
Guest - Ia on Tuesday, 10 June 2014 16:58

Thank you for your interesting comments.

Regarding to the frame of the report it uses data from 1990 to the latest available for each country group. The report itself you can find on this link:
http://www.adb.org/sites/default/files/pub/2014/ado-2014.pdf
(You can see the graph 2.1.3 for Share of education, health care, and social protection in GDP in 2010 for different country groups)

A few weeks ago Dr. Donghyun Park presented ADB Outlook 2014 at ISET (You can find short summary here http://iset.ge/index.php?article_id=852).

Thank you for your interesting comments. Regarding to the frame of the report it uses data from 1990 to the latest available for each country group. The report itself you can find on this link: http://www.adb.org/sites/default/files/pub/2014/ado-2014.pdf (You can see the graph 2.1.3 for Share of education, health care, and social protection in GDP in 2010 for different country groups) A few weeks ago Dr. Donghyun Park presented ADB Outlook 2014 at ISET (You can find short summary here http://iset.ge/index.php?article_id=852).
Guest - Ia on Tuesday, 10 June 2014 17:20

One more note, after reading this report I had sense that Asia achieved impressive growth without taking into account "inequality" at first stage. The main question for me is whether we can ignore inequality (and avoid unproductive fiscal spending on social benefits) and concentrate on growth like Asia?

I asked the same question to the Dr. Donghyun Park (principal economist of the Asian Development Bank ) and he answered that culture and soviet history of Georgia mattered a lot... In more details why "strong" and effective income redistribution policies (including direct cash transfers) are crucial for development of Georgia I will try to show in next blog.

One more note, after reading this report I had sense that Asia achieved impressive growth without taking into account "inequality" at first stage. The main question for me is whether we can ignore inequality (and avoid unproductive fiscal spending on social benefits) and concentrate on growth like Asia? I asked the same question to the Dr. Donghyun Park (principal economist of the Asian Development Bank ) and he answered that culture and soviet history of Georgia mattered a lot... In more details why "strong" and effective income redistribution policies (including direct cash transfers) are crucial for development of Georgia I will try to show in next blog.
Guest - Simon Appleby on Thursday, 12 June 2014 09:36

Most societies in Asia are hierarchical and not intrinsically egalitarian. Established social norms are for the masses to be obedient to authority, for those in authority to govern justly, unselfishly and benevolently, and for the wealthy to engage in private philanthropy and a benevolent paternalistic relationship with their employees. Of course this is the ideal and exceptions to this concept are common, but this is Confucian philosophy at its simplest. So "inequality" is not as inherently abhorrent to most Asian civilisations (even in Marxist countries like China and Vietnam) as in social-democrat model societies in Europe.

In this vein, governments in the Asian Tiger class from the 1960's onwards engaged in a range of social programmes to satisfy the expectations of benevolence that the masses held. In the case of Hong Kong, this was provision of heavily subsidised public housing to half the population, most of whom had been living in squatter camps after fleeing the Mainland in 1949. Very cheap public health services in government hospitals and very cheap universal education to the age of 15, provided by government schools and state-subvented private schools, ensured that the key needs of the poor were addressed, and that families could improve their situation by working hard in the fast-growing private economy, with skills required by industry taught in schools and vocational colleges. Singapore had a similar model. Indonesia, the Philippines and Thailand focussed their energies on cheap education and health care rather than housing, but they had much cheaper and more abundant land for private providers of low-cost housing to develop. Hong Kong and Singapore both maintained very low tax rates, very low or no minimum wages and a liberal labour policy to encourage development of industry and service enterprises to employ large numbers of people.

While there are plenty of exceptions (often centred around the electoral cycle), most of the Asian Tigers maintained the principle that the rising tide floats all boats, that inequality is not an inherent problem as long as the poor are becoming more affluent, and that welfare should be in the form of cheap basic services for the poor instead of cash payments, to encourage people to be industrious and elevate themselves out of poverty through their own efforts.

Most societies in Asia are hierarchical and not intrinsically egalitarian. Established social norms are for the masses to be obedient to authority, for those in authority to govern justly, unselfishly and benevolently, and for the wealthy to engage in private philanthropy and a benevolent paternalistic relationship with their employees. Of course this is the ideal and exceptions to this concept are common, but this is Confucian philosophy at its simplest. So "inequality" is not as inherently abhorrent to most Asian civilisations (even in Marxist countries like China and Vietnam) as in social-democrat model societies in Europe. In this vein, governments in the Asian Tiger class from the 1960's onwards engaged in a range of social programmes to satisfy the expectations of benevolence that the masses held. In the case of Hong Kong, this was provision of heavily subsidised public housing to half the population, most of whom had been living in squatter camps after fleeing the Mainland in 1949. Very cheap public health services in government hospitals and very cheap universal education to the age of 15, provided by government schools and state-subvented private schools, ensured that the key needs of the poor were addressed, and that families could improve their situation by working hard in the fast-growing private economy, with skills required by industry taught in schools and vocational colleges. Singapore had a similar model. Indonesia, the Philippines and Thailand focussed their energies on cheap education and health care rather than housing, but they had much cheaper and more abundant land for private providers of low-cost housing to develop. Hong Kong and Singapore both maintained very low tax rates, very low or no minimum wages and a liberal labour policy to encourage development of industry and service enterprises to employ large numbers of people. While there are plenty of exceptions (often centred around the electoral cycle), most of the Asian Tigers maintained the principle that the rising tide floats all boats, that inequality is not an inherent problem as long as the poor are becoming more affluent, and that welfare should be in the form of cheap basic services for the poor instead of cash payments, to encourage people to be industrious and elevate themselves out of poverty through their own efforts.
Already Registered? Login Here
Register
Guest
Tuesday, 22 October 2019

Captcha Image

Our Partners