Federalism linked to greater inequality, UP study finds

By Leo Jaymar G. Uy, Businesssworld, Sep 9, 2018

FEDERALISM is a “strong predictor” of higher income inequality in developing economies and higher poverty on average for all countries, a study by the University of the Philippines School of Economics (UPSE) said.

“The pro-federalism position claims that federalism will cause poverty to fall and the distribution of income to be more equal. Our regression results bear neither of these claims,” wrote economists Raul V. Fabella and Sarah Lynne Daway-Ducanes in a UPSE discussion paper, “Federalism and Inclusion in Developing Economies.”

“On the contrary, federalism strongly predicts greater income inequality in developing countries. Our results also show that federalism strongly predicts higher poverty incidence and severity on average: it does not reduce poverty incidence and severity in developing economies,” the report added.

The study covers 105 economies during the 1987-2016 period, and used the Gini coefficient as a measure of inequality while the poverty gap ratio and poverty head count ratios were used as measures of poverty.

The Gini coefficient looks at the distribution of a nation’s income and is most widely used as measure of inequality. The income distribution of a country is said to be more unequal the higher its Gini coefficient.

The poverty gap ratio shows the average shortfall of the total population from the poverty line (expressed as a percentage of the poverty line) — reflecting both the severity and incidence of poverty. The poverty head count ratio, meanwhile, is the percentage of population that lives below the poverty line.

For the poverty lines, the study used the World Bank’s “extreme poverty line” of $1.90 per day and the $3.2 per day standard for lower-middle-income countries.

Among the determinants used in the study were the real gross domestic product (GDP) growth rate, “trade openness” (expressed as a percentage of the sum of imports and exports against GDP), the International Monetary Fund’s financial institutional access index (expressed as bank branches per 100,000 adults and automated teller machines per 100,000 adults), and the inter-country risk guide (ICRG), a measure of institutional quality.

While the paper showed that federalism “negatively associates” with income inequality on average, it has an “inequality-increasing effect” in developing economies — defined in the study as those having a real GNI (gross national income) per capita of not more than $10,000 in 1992.

Meanwhile, it found that federalism “has either no effect or a poverty-raising effect.”

“The federalism dummy [variable] in each case has an unconditionally and strongly significant and positive correlation with poverty incidence and poverty severity. In the case of developing economies, it is shown that federalism has no effect at all on poverty incidence or its severity,” said Mr. Fabella and Ms. Daway-Ducanes in the report.

“Federalism thus appears to be on the wrong side of inclusion — in terms of both poverty reduction and greater income equality.”

The authors concluded: “On the debate whether we should shift to federalism, if inclusion is the criterion, our research results finds no support in favor of such despite the claims of proponents. Indeed, the results show that poverty incidence and income inequality could become worse. The contemplated shift appears to be a jump from the frying pan to the fire.”

The National Economic and Development Authority has proposed a five-phase transition to a federal form of government to avoid disrupting the economy’s growth momentum. Economic managers earlier warned that the proposed changes could cause the fiscal deficit to rise beyond the 3% threshold against gross domestic product ratio, the rule-of-thumb level for prudent borrowing.