Thursday, 15 December 2011

Beware the inequality trap

Singapore should consider more inclusive approach to social spending
By Donald Low & Yeoh Lam Keong, Published The Straits Times, 14 Dec 2011

INCOME inequality in Singapore has risen significantly in the last decade. Whether measured by the Gini coefficient or by the ratio of incomes between the top and bottom 20 per cent, the evidence points to a more unequal society. Government redistribution in the form of taxes and transfers has not slowed the increase in inequality sufficiently. According to the Ministry of Manpower's data on employed citizens, Singapore society after government redistribution is more unequal today than it was 10 years ago before government redistribution, as measured by the Gini coefficient.

Not only is income inequality rising, there are also certain aspects of Singapore's inequality patterns that make it especially worrying. To begin with, the increase in income inequality is accompanied by wage stagnation for some segments of the workforce. Between 2001 and this year, the median incomes for full-time employed citizens increased by just 11 per cent in real terms, while the 20th percentile saw no increase at all. Including part-time workers would likely show wage stagnation extending to a much larger proportion of the workforce.

Second, there are concerns that social mobility in Singapore has declined. Inequality is more tolerable if social mobility is high. Policymakers have tended to place greater emphasis on social mobility when discussing rising inequality, arguing that the former ameliorates the effects of the latter. But cross-country evidence suggests that more equal societies are also more mobile. Even if policymakers care mainly about equality of opportunity, they cannot ignore distributional concerns altogether.

Third, as a growing wealth of research indicates, people's well-being is affected as much by inequality - or relative incomes - as absolute incomes. Even if absolute incomes are rising across the board, rising inequality alone reduces subjective well-being.

Fourth, a more unequal distribution also makes it more difficult to have coherent policies that all segments of society can rally behind. Income stratification, especially if it is combined with low social mobility, may polarise societies as different income groups begin to see their interests as conflicting.

Singapore's social policies - founded on the ideas of individual responsibility, economic growth and jobs for all, and a social security system that emphasises savings and home ownership - have served Singaporeans well. They have enabled Singapore to achieve 'growth with equity' and delivered high standards in education, housing, health care and social infrastructure without imposing a huge burden on public spending.

But in the face of significant changes in Singapore's operating context - globalisation, rapid technological change, a maturing economy, an ageing population, greater economic volatility, and a more uneven distribution of the fruits of growth - Singapore's social compact needs to be re-examined and reformulated.

Targeted v inclusive approaches

IN MUCH of the policy discourse on inequality, the emphasis in Singapore has been on what (more) the Government should do for the poor. The implicit assumption here is that the state's role should be confined to poverty reduction, and that inequality by itself does not merit policy action.

This is consistent with the Anglo-Saxon or 'residual' model of social welfare. In this approach, social transfers are means-tested rather than universal. This model also envisages a smaller, less redistributive state since the aim is not to achieve more equal outcomes but to ensure no one falls below a certain absolute level. It is therefore ambivalent about the need for more government redistribution in the face of rising inequality.

Policymakers in Singapore generally subscribe to this more targeted approach of social welfare. They believe that government assistance should be limited, that it should help only those least able to afford basic services. The case for this residual model of social welfare is augmented further by the emphasis on the family as the first line of defence after the individual has exhausted his means, and by concerns over the fiscal sustainability of inter-generational transfers.

A second approach, favoured by the northern European countries, espouses the principle of inclusion and relies more on universal programmes that benefit the large majority of their populations.

These systems emphasise the government's role in redistributing incomes, and in fostering solidarity and social trust. Social scientists mostly accept that trust is correlated with a number of normatively desirable things. For instance, people who believe that most other people in their society can be trusted are more inclined to have a positive view of their public institutions, to participate more in civic organisations, to give more to charity, and to be more tolerant towards minorities and people not like themselves.

More inclusive universal social programmes raise social trust in at least three ways. First, because such programmes are more redistributive than means-tested ones, they result in lower levels of economic inequality after government taxes and transfers are taken into account. Second, since inclusive programmes are based on the principle of equal treatment, they increase the sense of 'equal opportunities' more so than means-tested programmes. Third, means-tested programmes often accentuate class divisions within a society, and lead to less trust. By contrast, inclusive programmes enhance solidarity and the perception of a shared fate among citizens.

Despite their appeal, inclusive and more universal social programmes that promote trust may be hard to establish in societies with already high inequality.

This is partly because these programmes often extend benefits to better-off groups which can be difficult to justify. Such societies may find themselves stuck in an inequality trap characterised by low levels of trust, an aversion to more inclusive and universal social programmes, and increased reliance on targeting to differentiate between those entitled to benefits and those who are not.

To be sure, inclusive universal social programmes have their costs too.

Broad-based benefits in child care, health care, elder care, pensions and unemployment protection cost more than means-tested ones. In northern European countries, generous benefits have to be financed by a wide range of higher taxes.

But policymakers should weigh the costs of inclusive universal programmes against their benefits in terms of fostering norms of fairness, and in promoting social trust, citizenship and solidarity. Whether the costs of such programmes exceed their benefits is an empirical, rather than theoretical, question.

Relevance for Singapore

IT WOULD be easy for Singaporean policymakers to dismiss the inclusive approach to social spending as too costly, too corrosive of Singapore's work ethic and too undermining of competitiveness. In Singapore's multi-ethnic context, given its heavy reliance on foreign investments, policymakers may argue that Singapore cannot afford the aggressively redistributive model of northern Europe.

Notwithstanding differences in contexts, there are still important lessons that the more universal approach offers Singapore. The first is that when designing social programmes, the traditional objectives of efficiency and getting incentives right should be complemented with an understanding of the norms that inclusive social programmes may help to foster.

In theory, means-tested programmes limit moral hazard and 'deadweight funding'. In practice however, they often result in high administrative costs, divisiveness and rent-seeking behaviours. For instance, the British government's efforts in the early 2000s to means-test state pensions resulted in people saving less so as to qualify for higher entitlements.

Pursuing a more inclusive approach to social spending in areas such as early childhood development, unemployment protection, health care and long-term care could strengthen norms of fairness, promote social trust and foster an egalitarian ethos. Within this approach, benefits can be structured progressively.

In elder care for instance, instead of only targeted subsidies, a basic tier of benefits could be considered for all older citizens who require long-term care, combined with means-tested ones for those with lesser means.

Second, policymakers should analyse social policies in terms of cost effectiveness, not just cost containment. A cost containment mindset focuses on keeping social spending as low as possible in the fear that transfers, once provided, fuel an insatiable demand for more. However, the key question is not how Singapore can keep social spending on a tight leash, but what kinds of social spending deliver the largest benefits and how an appropriate balance of universal and targeted policies can be designed. Applying this approach may well result in social policy choices quite different from the ones today.

Singapore's own history also suggests that large-scale, inclusive social programmes have generated the largest benefits. Its public housing programme, the heavily subsidised basic education system, and the large investments in public health, water and sanitation were largely universal. They fostered a sense of citizenship and helped to create the social conditions that supported economic growth.

Singapore needs the same boldness of using public monies to achieve desirable social ends to be applied to the policy challenges of today - an ageing population, wage stagnation, rising inequality and increasing health and long-term care needs. A narrowly targeted approach to these challenges may enable the government to maintain healthy surpluses, but would also result in missed opportunities to improve the welfare of citizens and bolster social trust. To avoid the inequality trap, Singapore needs not just expanded social safety nets, but also more inclusive ones.

The writers, both of whom used to work for government agencies, are vice-presidents of the Economic Society of Singapore.

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