1 ECONOMIC GROWTH AND WAGE INEQUALITY DURING PORTUGAL’S ESTADO NOVO, 1945-1974 Pedro Lains1, Ester Gomes da Silva2 and Jordi Guilera3 November 2007 Abstract This paper relates the changes in the structure of the Portuguese economy during its golden age of growth, from 1945 to 1974, to changes in wage inequality at the national level. The paper also aims at contributing to a better definition of the political nature of the Portuguese dictatorial regime. We present a new data set based on surveys conducted by the National Statistics Office (INE), which are put together for the first time. The data covers the whole economy and includes 17 sectors plus data on skilled and unskilled labour, as well as data on male and female labour force in agriculture. We estimate a Theil index for wage inequality that reveals an inverted-U Kuznets’ curve with a peak in 1959. The fact that wage inequality declined after 1959 leads to the conclusion that the fall of the dictatorship in 1974 was not preceded by an increase in social injustice. Finally, the paper estimates econometrically the relationship between wage inequality and per capita income growth, controlling for the influence of additional variables that capture the effects of industrialization, investment in human and physical capital, emigration, foreign trade and the size of the government. Keywords: Kuznets curve; Wage Inequality; Structural change; Portugal. JEL-Codes: D31, O15 1 [email protected]; Instituto de Ciências Sociais, University of Lisbon. 2 [email protected]; Faculdade de Letras, University of Oporto. 3 [email protected]; University of Barcelona. 2 1. Introduction Between 1945 and 1974, the Portuguese economy experienced deep transformations, which included rapid industrialization, opening up to international trade, the increase in State intervention, as well as urbanization. It is our purpose in this paper to relate changes in the structure of the economy with changes in wage inequality at the national level. We want to explore the impact of the size of the industrial and export sectors on the dispersion of wages within the country. We also analyse how the increase on the size of the government and large- scale emigration impacted on inequality. The analysis of wage inequality is also relevant for a better understanding of the political nature of the Portuguese regime. During the period under analysis, Portugal was ruled by a dictatorial regime, the Estado Novo, which repressed political rights and is frequently pictured as being an anti-labour regime which favoured large scale industrial and agricultural capitalists4. The Estado Novo had its origins in a military coup in 1926, and was institutionalized after Salazar became Prime Minister, in 1932, and a Constitution was approved by plebiscite in the following year. During the years from 1926 to the mid-1930s, the dictatorial government was particularly tough and many expected that the regime would open up after 1945, under the influence of Western democratic governments. Yet, the advent of the Cold War, in the early 1950s, turned Salazar’s regime bearable to Western governments and the pressure to change died out. In the following decades, an ageing dictator secured a tight grip on the country and the regime became more and more closed and isolated from democratic influences. Salazar left power due to his health condition in 1968 (he died in 1970), and his successor was unable to introduce significant changes because of the colonial war in Africa and also because of the semi-presidential character of the regime5. The dictatorship came to an end finally in 1974 with another military coup. The analysis of wage inequality provides a better understanding of the evolution of social pressures to change the regime that occurred with the 1974 coup d’état. The dictatorship is frequently characterized as socially unfair. And the fact is that Portugal still was one of the most unequal countries in Western Europe in 1974 and remains so in the present times6. But what happened to wage inequality during Salazar’s long reign? 4 See for example Rosas (1994). 5 The President of the Republic, who was a minor figure whilst Salazar was in power, had a crucial role in the survival of the regime to 1974. A survey of Portugal’s political history is provided by Pinto (Ed.) (2003). 6 According to Silva (1982), in 1973, about one third of Portuguese households were poor (Silva, 1982: 1079). 3 Despite the interest on the matter, the analysis of income inequality during this period has remained a relatively unexplored issue, with only a few authors addressing the topic.7 Based on qualitative insight and the partial evidence for the 1970s, Manuela Silva (1982) has posited that industrialization and urbanization was responsible for the increase in income inequality during the period from 1950-1974.8 Castanheira and Ribeiro (1977) show an increase in the Gini coefficient between 1967-68 and 1973-74, from 0.35 to 0.39, but an increase in the income share of the bottom 25 percent share of the families (Castanheira and Ribeiro, 1977:1081-1082). On the other hand, Pereirinha (1988) goes in the opposite direction. Based on industrial wages for the period from 1953, he finds an inverted-U curve with the peak of maximum wage inequality in 1959. Regarding household income inequality, he shows a slight reduction of inequality between 1967-68 and 1973-74.9 More recently, Guilera (2007) shows an increase of top income shares after WWII that lasted until the early fifties and a reversal of the trend in the following three decades. The data set we use provides the most complete coverage in terms of economic activity and time span. It is also highly representative of the income of the labour force, as about 75 percent of it was formed by wage earners. The paper is structured as follows. Next section sets down the theoretical framework. Section 3 presents the macroeconomic background in terms of trends in growth rates, structural change and degree of openness of the Portuguese economy. Section 4 presents an overview of the data. Section 5 discusses the evolution of wage inequality in Portugal during the period under study. Section 6 attempts to provide an explanation for the observed inequality trends. Section 7 concludes. 2. Inequality and growth: theory and evidence The relationship between inequality and growth is far from being established. In theoretical terms, higher levels of inequality can foster growth if savings rates rise with income levels (e.g., Lewis, 1954; Kaldor, 1957). Yet, inequality can also hamper growth if the rich invest unproductively, if it induces distributional conflicts and political instability (e.g., Persson and Tabellini, 1994; Aghion et al., 1999), or if it is associated with lower levels of human capital held by the poor. In this respect, Galor and Zeira (1993) showed that higher inequality may have a negative impact on economic growth if capital market imperfections limit human capital 7 See, for example Pereirinha (1988) Carvalho and Moura (1964), Carvalho (1967, 1969), Castanheira and Ribeiro (1977), and Silva (1982). 8 This was inferred from the fact that at the end of the period, in 1973, poverty rates in the urban areas were lower then in the rural areas (Silva, 1982: 1081-1082). 9 The Lorenz curves for both years are, however, crossed, which hampers a precise statement of the evolution of inequality during this period. 4 accumulation. At this level, Barro (2000) stated that capital market imperfections were more damaging in poor countries, and that was the reason why the negative relationship between inequality and growth only existed in such countries,. Inequality may also affect growth through its influence on the definition of government policies. More precisely, it may lead to an increase in social spending, particularly in democratic countries, where the masses have a larger share of political power. This in turn may lead to different outcomes. On the one hand, it may divert taxed income from investment towards higher consumption levels by the poor, diminishing the country’s growth potential. But, on the other hand, it may stimulate growth, if it increases the lower classes’ human capital.10 Yet, Benabou (1996) criticized both models because two of the unrealistic character of their premises. More precisely, he found that neither higher inequality was associated with higher redistribution, nor higher redistribution was associated with lower growth. More recently, Rodrigues (2004) provides a theoretical model that relates higher inequality with lower redistribution and more rent-seeking activities that divert public resources towards unproductive investments that harm economic growth. In empirical terms, the evidence regarding the impact of inequality on economic growth has led to contradicting results. A significant number of studies focusing on world income inequality conclude that inequality is harmful for growth, but their results have been put into question because of the poor quality of data. At the same time, studies using fixed effects estimates to take into account omitted country specific effects have reached different results. As Banerjee and Duflo (2003: 268) summarize, ‘while OLS regressions typically found a negative relationship between inequality and subsequent growth, the fixed effect approach yields a positive relationship’. From a different point of view, growth can also have an influence on inequality, though the precise assessment of its impact may be difficult to disentangle from the influence of other factors. During the early phases of development, countries may experience an increase in income inequality, as population shifts from informal and low paid agricultural jobs to manufacturing and service sectors, which have both higher productivity and wage levels (Kuznets, 1955). Moreover, labour supply in developing countries tends to be elastic (Lewis, 1955), whereas capital supply is less elastic.