This draft: 14/04/2009 What explains the recent decline of income inequality in Latin America? Giovanni Andrea Cornia 1 Abstract. This paper reviews the decline in income inequality that has taken place over 2002-2007 in several Latin American countries against the background of its steady increase between 1980 and 2002. The paper analyzes the factors that could explain this decline in inequality, and that may raise it during the current crisis. It focuses in particular on favorable external conditions, cyclical factors, improvements in the distribution of educational achievements, and changes in macroeconomic and social policies introduced in several countries, particularly in the increasing number of left-of-centre governments which have come to power during the last decade. The paper tests econometrically the above four hypotheses on the basis of a database including 18 countries for the years 1990-2007. The results indicate that, in addition to an improved business cycle and favorable terms of trade, the new policy model of fiscally prudent social-democracy which is emerging in much of Latin America generated a favorable impact on the distribution of income. This suggests that, if the above policy approach will survive the current crisis, part of the recent inequality decline will be permanent rather than temporary. 1. Introduction. The gloom and doom caused in Latin America by the current financial crisis has obscured the positive changes that have taken place in the region since 2002. The most evident of them is the economic boom which has lasted till 2008. Indeed, over 2003-2008 the yearly growth rate of GDP averaged 5.5 percent for the region as a whole, lower only to that registered over 1967-74 (Ocampo 2008). Such steady expansion of output was to some extent a rebound from the stagnation recorded during the “half lost decade” of 1998-2002, but featured also a sharp increase in the investment rate that reached 21-22% of GDP, up from 16-17 % in 2002, and lower only to that reached at the end of the Seventies. The boom was accompanied also by a nine percentage points decline in the poverty rate and a significant drop in inequality. The same period recorded other important changes which likely affected economic growth and the distribution of income, but which are less frequently emphasized in the literature. The first of such changes concerns the steady gains in educational achievements realized since the beginning of the 1990s by both center-right and left-of-center (LOC) regimes and the parallel decline in many aspects of educational inequality (Gasparini et al. 2009). As labor represents the main productive 1 The author would like to acknowledge comments on prior versions of this paper received by Michael Grimm and other participants to the Conference on ‘Work, Employment and Globalization’ held at ISS (Den Haag) on18 September 2008, and by Abhijit Sen and other participants to the Conference on “The Impact of the Financial Crisis in India” held at the Tata Institute of Social Sciences (Mumbay) on 13-15 March 2009. He is also grateful for comments received from participants to seminars he gave at the University of Montevideo on 30 September 2008, the UN House in Asuncion on 2 October 2008, and CERDI, University of Auvergne on 5 December 2008. The author would also like to thank Bruno Martorano for outstanding research assistantship. Of course, all remaining errors are only mine. 1