The Role of the Economic Environment

The preceding chapters have explored the determinants of income inequality at the level of the individuals and families who live, work and raise their children within a national economy. We have seen that certain key characteristics of the individuals in the family, most notably the education of the household’s adult members, are important determinants of the household’s decisions about labor force participation, fertility and the education of the children. The household’s decisions interact with the economic environment that surrounds them—wages and employment opportunities—to determine household income and the earning capacity of the next generation. The message has been that a substantial part of income inequality in the region is attributable to differences across households in educational attainment and in other characteristics that determine household earning capacity. Thus, an important part of the Latin American income inequality story is that education and other determinants of earning capacity are unequally distributed across the population. This is an important part of the story, the policy implications of which are very different from those that would have followed, for example, from a finding that the large differences in household earnings were inexplicable and unrelated to education or other individual characteristics. But we have also learned that this is not the whole story. This is so for two reasons. First, we have so far shed only limited light on why the distribution of education and other determinants of earning capacity are so skewed in Latin America, and why they are so much more skewed in some countries of the region than in others. And further, we have uncovered evidence that a given difference in educational attainment or some other determinant of earning capacity generates much more inequality in some countries of the region than it does in others. It seems that in some countries there is something about the economic environment that translates a given difference in educational attainment into a larger difference in earning capacity, thus generating more unequal distribution of income, which is then amplified and transmitted to the next generation through the family decisions described in the previous chapter. To understand this part of the story, we turn our attention away from detailed investigations of individual household behavior within a country, where households face a relatively common economic environment, and toward comparisons across countries, where we find some key differences in the underlying economic environment. We can then try to learn how these differences affect distribution of income. To motivate the discussion that follows, let us return for a moment to the Altamira and Bajares families introduced in Chapter 3. The families were identical in all respects except in the education of the family’s adults. The more educated Altamira family had higher income than the Bajares family in all countries of the region, but that gap in income was much larger in some countries than in others; something about the economic environARGENTINA BOLIVIA