Research Brief
The Causes of the Decline in Income Inequality in Latin America

Addressing continued inequality

In recent years, many Latin American countries have enjoyed sizeable drops in income inequality. Such a decline has no parallel in other developed or developing regions. The reasons behind this have differed from country to country, but a few common factors stand out from the research. 

• On average, improvements in external conditions—especially an increase in the volume of exports from Latin America and increased prices for commodities—played a perceptible role in reducing inequality by raising incomes, employment, and revenue collection.

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  Over the last three decades Latin America has seen an increase in the working age population relative to people of non-working age, as well as a higher participation rate of the poor in the workforce. These factors contributed in a direct but minimal way to the recent improvements in the distribution of income per capita.​
• This decrease in the skill premium appears to have played a central role in improving the distribution of income. While the reasons for this require further research, it is clear that a steady and equitable rise in investments in education had large and favourable effects.​
• The 2000s recorded a remarkable shift in political preferences towards progressive regimes, which introduced reforms committed to reducing inequality. In most countries, this included policies such as managed exchange rates, neutral or countercyclical fiscal and monetary policy, rapid accumulation of reserves, and an active role of the state in labour and social welfare policies.

In much of the region, an increase in tax revenue through changes in tax policy as well as rising minimum wages appear to have influenced the recent inequality trend. Increased social expenditure on schemes like conditional cash transfers were also significant. In contrast, the recent shifts in exchange rate policy in favour of devaluation contributed only modestly or not at all to the recent inequality decline.

The continued decline in inequality during the 2009 crisis suggests that the new inequality trend is likely to stick. If the 2002-10 pace of the decline in inequality were to continue for another two to three years, it would bring the region back to the inequality levels of the early 1980s. More structural reforms will then be required––at least in the poorest part of the region––to deal with the deep-seated structural inequality that has affected the region since the beginning of the last century. 

Addressing continued inequality

Despite the recent decline, the inequality level of most of Latin American countries remains extremely high, and Latin American governments face formidable hurdles in deepening reforms. First, the trend towards rising taxation and social expenditure needs to continue in most of the region, with the objective of building a lean welfare state that aims at universal coverage over the long term. 

Second, political opposition to intensification of the new policy model may need to be overcome, as shown by events in Bolivia, Honduras, and Argentina, where interest groups have nearly stalled attempts at redistribution. 

Finally, the inherent structural biases of the Latin American economy––such as the lack of explicit industrial policies, low rates of domestic savings and the related dependence on foreign capital, continued pressures towards real appreciation of currency, and economies dependent on export of commodities––threaten the possibility of shifting to an equitable and sustainable long-term growth path. Without changes in these areas, it is unlikely that the region will be able to tackle its structural inequality by diversifying the economy into new labour- and skills-intensive sectors.​