Why income inequality is at its highest in India
Economic growth is fundamental to reduce poverty and inequality. When economy grows faster, it should ideally lead to an equitable growth in income for all sections of population. But that’s always not the case. Despite a sharp fall in inequality around the world, inequality has witnessed upward trends in some of the large economies.
Market economies are bound to be unequal. Unequal growth is not specific to large economies like the US, China and India alone. But what’s striking about India is that it is the country with a glaring glitch in its growth: highest gap between the growth of top 1 per cent and the rest of the population. India is also more unequal than China and incomes of those at the top have grown at a faster pace than in China.
Rising income inequality is a major problem in India because the distribution of gains of growth has been extremely uneven. This is best highlighted in an incisive paper by renowned economists Thomas Piketty and Lucas Chancel. Piketty is the author of Capital, a 2013 bestseller on capitalism, which documents the rise of sharp income inequality in the developed world since the 1970s.
Some reports suggest that almost 50 per cent of the world’s poor live in India. According to Tendulkar Committee report of 2012, 26 per cent of all people in India fall below the poverty line of US $ 1.25 per day. According to Indian government, the poverty line for rural areas is Rs. 673 per month and 860 for urban areas. This means that there are more than 220 million people below the official poverty line, though in reality the number could easily go beyond 300 million.
Economic reforms began in mid-1980s and since then poverty in India has witnessed a consistent decline. Liberalisation of economy and redistribution of income through various employment and welfare schemes besides subsidies for the poor have lifted more than a 100 million Indians out of poverty.
However, in their latest work on income inequality in India – Indian Income Inequality, 1922-2014: From British Raj to Billionaire Raj – Piketty and Chancel contend that “there has been a sharp increase in wealth concentration from 1991 to 2012”. Their conclusion: India has only been shining for the top 10 per cent (80 million) of the population and not the middle 40 per cent. The main points of Piketty-Chancel paper are: the bottom 50 per cent of the Indian population accounts for only 15 per cent of the national income; the middle 40 per cent of the population accounts for 30 per cent of national income; the top 10 per cent of the population accounts for 55 per cent of the nation’s wealth. In 1982-83, the share of the national income for the bottom, middle and top sections of population were 24, 46 and 30 per cent.
The key finding of Piketty-Chancel paper is quite startling: the share of the rich in the national income after falling steadily between 1930s and 1970s, started rising from the 1980s onwards and reached the historical high in 2014.
Over the same period, the share of the middle income population and those at the bottom of pyramid showed a reverse trend. It is obvious that the top 10 per cent whose wealth rose exponentially and is rising by the day seem to have benefitted the most from India’s strong income growth of last 25 years. Piketty and Chancel combined income tax data, household income and consumption sourced from national household surveys to track income inequality.
The duo used income tax data for the richest 5 per cent and consumption survey data for others. If one leaves aside the contentious issues relating to measurement methodology, the authors’ broader conclusion is: when Indian economy was under strong policy regulation between 1950s and 1970s, the top income shares were lower relative to the middle and lower classes. But the trend reversed with opening of the economy.
Why did this happen? Strong government regulation and rigid policies keep growth levels low. This was the case from 1950s to 70s when India’s growth rate was barely 3 to 3.5 per cent. When growth remains low, it keeps average income levels down. It also keeps more people poor for lack of opportunities. At the same time it keeps asset prices under check.
When rules are dismantled and economy is freed from control, it leads to higher growth, opportunities and enterprise. The ones who take advantage of opportunities are obviously those who are rich, enterprising and have access to capital. This leads to a bump up in income and wealth creation in the top class, while excess supply of skilled and unskilled labour keeps wages low for the middle and lower classes. This leads to higher inequality in income and explains why inequality increased during the high phase of growth, as growth rates of the richer class was much higher than the growth rates of those in the middle and at the bottom.
According to Piketty and Chancel, a similar trend of rising inequality emerged in China and Russia as well. China for instance, opened up its economy in the late 1970s and experienced a sharp income growth as well as a sharp rise in inequality. The rise was however stabilised in the 2000s and is currently at a lower level than India. Moving from communism to market economy, the transition was swift and brutal but today Russia also has similar levels of inequality as India. On the other hand, the highest growth rate in Western Europe, after the Second World War II, was also a period of equitable redistribution of fruits of growth. That’s because, according to the economists, Europe grew as a market economy, but did not become a market society. There are different strategies to transit from a highly regulated economy to a liberalised one. According to the economists, India pursued a very unequal way. “India not only open up and liberalise its economy, it did in a way that was favourable to top income earners and capital owners,” say the economists. To address the anomaly in income, appropriate policy measures are needed to promote inclusive growth. A corrective measure to limit rising income inequality at the top, in Chancel’s view, is more tax progressivity. At the middle and lower end of the socio-economic ladder, significant investment in healthcare and education besides land reforms will play a key role in raising their income.
WHY DID THIS HAPPEN? Strong government regulation and rigid policies keep growth levels low.This was the case from 1950s to 70s when India’s growth rate was barely 3 to 3.5 per cent.When growth remains low, it keeps average income levels down. It also keeps more people poor for lack of opportunities. At the same time it keeps asset prices under check.