Between 2000 and 2010, the Gini coefficient declined in 13 of 17 Latin American countries. The decline was statistically significant and robust to changes in the time interval, inequality measures and data sources. In depth country studies for Argentina, Brazil and Mexico suggest two main phenomena underlie this trend: a fall in the premium to skilled labor and more progressive government transfers. The fall in the premium to skills resulted from a combination of supply, demand, and institutional factors. Their relative importance depends on the country.

Based on results from non-parametric decomposition exercises, in Argentina, Brazil and Mexico, the decline in overall inequality can be attributed to a decline in both labor and non-labor income inequality. In the case of Argentina and Mexico, the decline in labor income inequality contributed with a larger share while in Brazil the contribution was approximately equal (until 2006) and then labor income's contribution started to dominate.

The decline in labor income inequality can occur because of an expansion of employment and/or hours worked (especially among the poor) and by changes in the distribution of hourly wages. The latter, in turn, can be driven by changes in the distribution of observable (and unobservable) characteristics, and changes in returns to those characteristics. The analysis for Argentina suggests that the expansion of employment (as a result of the economic recovery and commodity boom) was an important factor behind the decline in labor income inequality. In the cases of Brazil and Mexico, this was not the case. Whether the changes in the distribution of characteristics (the quantity effect), especially education, were equalizing or unequalizing could not be unambiguously established for Argentina and Brazil because different authors obtained opposite results. In the case of Mexico, all the authors found that the more equal distribution of education had an unequalizing effect on labor income. That is, Mexico is still experiencing what Bourguignon et al. (2005) called a “paradox of progress.”

In the three countries the changes in returns to education and experience (the price effect) were equalizing. This is in stark contrast with trends in the 1990s when the skill premium rose across the board. The skill premium is affected by demand and supply of workers of different skills (education and experience) and by institutional factors such as the minimum wage and the influence of unions. Labor demand by skill, in turn, is primarily affected by the characteristics of technical change and international trade. The composition of labor supply is determined, to a large extent, by the characteristics of educational upgrading and demographic factors.

Based on the results analyzed here, the fall in the skill premium in Argentina is explained by a decline in relative demand for skilled workers, and a rise in the minimum wage and the power of unions. In Brazil, supply-side factors - in addition to demand-side and institutional factors - played an important role. In Mexico, institutional factors were unimportant and demand for skilled labor may have even continued to rise; the fall in the skill premium, thus, was primarily driven by an expansion in supply of skilled workers.

In Brazil and Mexico, then, the decline in labor income inequality was linked to the fact that unskilled labor became (relatively) less abundant. The significant expansion of basic education that underlies the change in labor composition by skill in these two countries, in turn, seems to be associated with conscious government efforts including administrations from earlier periods. Higher spending per student in basic education and an effort to make education accessible in rural areas eased supply-side constraints (Santibanez, et al., 2005). In addition, the conditional cash transfer programs Bolsa Família (Brazil) and Progresa/Oportunidades (Mexico) reduced demand-side constraints by compensating poor households for schooling costs and the opportunity cost of children’s labor.

In the three countries analyzed here, the demand for skilled labor in the 2000s appears to either have declined (Argentina and Brazil) or grown at a slower pace (Mexico). What explains this change of pace in the demand for skilled labor? No clear-cut answer exists as of yet. Candidates are changes in the composition of output and employment induced by policy changes (trade and industrial policy, for example) as well as exogenous changes in the composition of global demand and terms of trade. Gasparini et al. (2011) find econometric evidence in support of the role of terms of trade for the 16 countries included in their regression analysis: that is, an improvement in the terms of trade results in a reduction in the skill premium. This result is statistically significant across many specifications (Gasparini et al., Table 4.1). When these authors try to link this result to changes in the skill composition of employment between and within sectors, however, no clear answer emerges. That is, as a general observation there is no evidence of a change in the structure of employment towards sectors using unskilled labor more intensively. Thus, so far, a more fundamental explanation of the weakening of the demand for skilled labor has eluded us.

The reduction in inequality of non-labor income was the second major factor behind the decline in inequality. Non-labor income includes quite disparate income sources: returns to capital (interests, profits and rents), private transfers (for example, remittances) and public transfers. The contribution of changes in returns to capital in the three countries tended to be small and unequalizing. Mexico is the only country for which a separate analysis of private transfers (mainly remittances) is done; remittances proved to be equalizing and became even more so in the 2000s, because they closed the gap between rural and urban household per capita incomes, particularly in the case of Mexico.

The most important factor in accounting for the decline in non-labor income inequality was a significant rise in importance of the equalizing contribution of government transfers. The equalizing contribution of government transfers not only rose over time but was of such a significant magnitude that it offset the unequalizing effect of other sources of non-labor income. Schemes like Benefício de Prestação Continuada (Brazil), Procampo (Mexico), and large-scale conditional cash transfers programs (CCTs) such as Jefes y Jefas (Argentina), Bolsa Família (Brazil) and Progresa/Oportunidades (Mexico) had remarkable redistributive power. The CCTs are a small share of total government social spending but go a long way in terms of redistributing income to the bottom of the distribution.The expansion of their coverage during the 2000s was, in particular, key to both inequality and poverty reduction. Overall, the important contribution of social policy to the reduction of inequality through the expansion of education and public transfers is evident.

The redistributive momentum may be hard to sustain, however. While educational attainment has become significantly more equal, the same cannot be said about the distribution of the quality of education. The experience of the United States should serve Latin America as a warning of what may be yet to come.(Goldin and Katz, 2008). In the United States, earnings inequality rose significantly since the 1980s because the premium to skills increased. Returns to skills went up because there was a slow-down in the rate at which workers with post secondary education came into the labor market (and to a lesser extent because of skill-biased technical change). The low quality of education in preceding levels generated many high school graduates who were not “college ready” and, thus, educational upgrading stalled. In addition, favorable terms of trade cannot be taken as a given. Latin America has experienced recurrent ups and downs associated with terms of trade throughout its history. The decline in inequality cannot be taken for granted. It requires “hard work” both from policymakers and the polity.

Based on Nora Lustig, Luis F. Lopez-Calva and Eduardo Ortiz-Juarez "Declining Inequality in Latin America in the 2000s: The Cases of Argentina, Brazil, and Mexico" World Development, forthcoming".