Latin America has recently made unprecedented progress in reducing income inequality, and labor markets have played a critical role in this process. Evidence from household surveys of 15 countries from 1995 to 2010 suggests that labor income still accounts for the highest share of total per capita household income; moreover, surveys also show that differentials in earnings remain the main contributor to inequality in the region. That said, recent findings point that over the past 15 years, labor income has become less unequal and net job creation has proportionally benefited the least well-off, and combined these factors have been the main drivers in the observed reduction of inequality in the recent years.

The fall in inequality has also played an important part in reducing poverty in the region. The analysis of the recent decline in the region’s poverty rate suggest that inequality contributed significantly more over the past decade than it did in the period 1995-2000. In fact, between 2000-2005 and 2005-2010, the decline in inequality accounted for 58 and 37 percent, respectively, of the total poverty reduction in Latin America. In the case of extreme poverty, the ratios were close to 44 and 40 percent, respectively (Azevedo et al, 2013).

What about labor market earnings? Azevedo et al (2013) decomposed hourly labor market earnings into quantity, price and within-group (residuals) effects using an extension of the Junh-Murphy-Pierce decomposition (1996) proposed by Fogel and Azevedo (2007). This framework is used to explain the trends in, and drivers of, labor income inequality in the region. It also serves to highlight the differences in patterns across Latin American countries. Employing different measures of inequality, this work shows that the price effect (which captures returns to skills such as education and experience) has, on average, comprised the main driver of the inequality decline in the region’s labor markets (Figures 1 and 2).

Going forward, it is important to remember that inequality in the region remains high. The least unequal country in Latin America (Argentina), for example, is still more unequal than the most unequal country in the European Union (Ireland) (Figure 3). Given this, three factors should be considered in the path towards further inequality reduction in the region.

First, improved access to education needs to be coupled with improvements in skills. The educational system must therefore strengthen its ability to generate skills that are valued in the labor market (Aedo and Walker, 2012); in other words, quality of education and skills are the new margin for inequality. A recent study tests for the intergenerational persistence of inequality using PISA scores8 and finds that Latin American countries have relatively higher rates of intergenerational persistence of inequality in educational achievements than, for example, countries in Asia (Ferreira and Gignoux, 2010). Also employing PISA data, the Human Opportunity Index for quality of education is consistently lower for science, mathematics and reading for Latin American countries than countries in Europe and North America (Molinas et al., 2010)

Second, as Gasparinni et al. (2011) and Yeyati et al. (2013) suggest that the observed reduction in the return to skills can be associated partly with trend reversal in labor demand during the 2000s. This could relate to the recent boom in commodity prices that arguably favors the unskilled (non-tertiary educated) workforce. Such technological diffusion or skill mismatches may reduce the labor productivity of highly educated workers. This could potentially undermine the prospects of sustained growth in the region.

Third, the proportion of working-age adults in Latin America is growing as the region undergoes a demographic transition. Consequently, the region is currently benefiting from a demographic dividend that can provide resources for investments that are designed to reduce inequality and poverty. This favorable scenario is projected to continue until around 2020, when this ratio of workers/retirees should reach its maximum. The scenario will then start to decline due to the growing proportion of older people and a relatively smaller workforce. It is important to note that, while such demographic transition lasted for over a century in developed countries, these changes are occurring much more quickly in Latin America and other developing countries today. France, for instance, had 115 years to accommodate the doubling of its elderly population (from 7 percent to 14 percent). In Latin America, this process is happening much more quickly, and the adjustment will therefore need to be quicker as well. Chile is projected to face this change in 26 years, Brazil in 21 years, and Colombia in 19 years (Cotlear, 2010).

Based on: Azevedo, João Pedro, Maria Davalos, Carolina Diaz-Bonilla, Bernardo Atuesta and Raul Andres Castañeda (2013). "Fifteen years of inequality in Latin America: how have labor markets helped?," Policy Research Working Paper Series 6384, The World Bank. http://ideas.repec.org/p/wbk/wbrwps/6384.html

Disclaimer: The findings, interpretations, and conclusions expressed in this paper are entirely those of the author. They do not necessarily represent the views of the International Bank for Reconstruction and Development, World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.

* Joao Pedro Azevedo is a Senior Economist at the World Bank in Washington DC. He currently works for the European and Central Asia region on Tajikistan and Turkey, and leads ECA Stats Team. João Pedro has worked extensively to help developing countries improve their systems for better evidence-based decision making, working in Colombia, Brazil and the Dominical Republic for five years, and leading important regional public goods such as the LAC Stats Team and the LAC Monitoring and Evaluation Network (http://redlacme.org/). He brings solid and varied experience in applied econometrics in the field of poverty and inequality, tools for public sector monitoring and evaluation, and innovations on high-frequency data collection using mobile phones (L2L), the use of Big Data for policy making and the design of iBooks and Data visualizations. Prior to joining the Bank, Joao Pedro worked as the Superintendent of Monitoring and Evaluation at the Secretary of Finance from the State of Rio de Janeiro, a Research Fellow at the Brazilian Institute of Applied Economic Research (IPEA). He was a former Chairman of the LACEA/IADB/WB/UNDP Research Network on Inequality and Poverty (NIP).

References:

Aedo, C. and I. Walker (2012). Skills for the 21st Century in Latin America and the Caribbean. Directions in Development Series. World Bank.

Azevedo, João Pedro, Maria Davalos, Carolina Diaz-Bonilla, Bernardo Atuesta, and Raul Andres Castañeda (2013). "Fifteen years of inequality in Latin America: how have labor markets helped?," Policy Research Working Paper Series 6384, The World Bank.
http://ideas.repec.org/p/wbk/wbrwps/6384.html

Cotlear, Daniel (Editor) (2010) “Population Aging: Is Latin America Ready?,” The World Bank: Washington, DC.

Ferreira, Francisco H. G. and Jérémie Gignoux (2010) “Educational Inequality and its
Intergenerational Persistence: International Comparisons”.

Foguel, Miguel Nathan and João Pedro Azevedo (2007), “Decomposição da desigualdade de
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da queda recente, Ricardo Paes de Barros, Miguel Nathan Foguel and Gabriel Ulyssea eds., vol. 2, ch.
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Gasparini, L., S. Galiani, G. Cruces and P. Acosta. (2011) “Educational Upgrading and Returns to Skills in Latin America Evidence from a Supply-Demand Framework, 1990-2010.” CEDLAS Working Paper.

Yeyati, EL, A de la Torre, and S Pienknagura (2013) “Latin America and the Caribbean as Tailwinds Recede: In Search of Higher Growth, LAC Semiannual Report,” April 2013.