Studies have found that income inequality negatively affects growth. In pic, a woman sells decorations in Bengaluru.
Credit: DH Photo/Pushkar V
Niti Aayog’s CEO believes poverty is now down to below 5% in India. But then why is the government giving free cereals for the last four years to two-thirds of India, and why will it continue to do so till 2029?
Poverty and inequality are linked. The World Inequality Lab (WIL), a global research centre, published its recent working study, ‘Income and Wealth Inequality in India, 1922-2023: The Rise of the Billionaire Raj’. The study presents facts about inequality, which we recount here.
When it comes to income inequality, 22.6% of India’s national income in 2022-23 went to the top 1%, the highest proportion in the last 100 years. For wealth inequality, the share of the top 1% in wealth was as high as 40.1% in 2022-23, also its highest level since 1961. The share of wealth among the top 10% increased from 45% in 1961 to 65% in 2022-23. Conversely, the share of the bottom 50% and middle 40% in wealth has declined: The rich got richer and the poor got poorer.
India’s wealth inequality is not as extreme as Brazil and South Africa, but its wealth concentration has already increased threefold between 1961 and 2023. Additionally, with India’s income inequality being the world’s highest, higher than South Africa, Brazil and the United States of America, it will only add to wealth inequality in times to come.
According to the WIL study, between 2014-15 and 2022-23, “the rise of top-end inequality has been particularly pronounced in terms of wealth concentration”, making India now more unequal than the British Raj.
Why inequality matters
Economists, even conservatives, have become concerned about the growing inequality. Recent International Monetary Fund (IMF) studies have found that income inequality negatively affects growth and its sustainability. Another IMF study goes further: It finds an inverse relationship between the income share of the rich and economic growth. Thus, if the share of the top 20% of the population increases by 1 percentage point, GDP growth is actually 0.08 percentage points lower in the following five years, suggesting that the benefits do not trickle down. Instead, a similar increase in the income share of the bottom 20% is associated with 0.38 percentage points higher growth.
The adverse impact of inequality on growth is important to consider, as growth is critical to the reduction of poverty; the greater the inequality, the lower the impact of growth on poverty reduction.
Second, the literature also establishes that the super-rich affect decisions by being in and out of the corridors of power.
The recent electoral bonds episode have demonstrated what was always known — that the super-rich are influencing decisions, leading to the exclusion of others from competition and undermining social impact and environmental impact decisions — thus undermining citizens’ rights.
Third, inequality dampens investment, and hence growth, by fueling economic and political instability.
Fourth, the enhanced power of the elite could result in a more limited provision of public goods that boost productivity and growth, and which disproportionately benefit the poor. We are already seeing evidence of three and four in India.
Policies to reduce inequality
Much can be done to reduce inequality. First, growth strategies that generate non-farm jobs (and promote structural change) are ones that could lead to pro-poor growth, which would also be inequality-reducing. This is especially true in countries where the working-age population is still rising: All of Sub-Saharan Africa and South Asia. India is failing here.
Second, the most important marker of structural transformation, which was accompanied by rising equality in now-industrialised countries, was not only the absorption of surplus labour from agriculture, but also the rising share of the formal workforce, with access to social insurance.
The majority of the 1.7 billion poor in the world depend exclusively on their labour for survival, emphasising the key importance of employment for poverty reduction. But employment should come with old age pension, death/disability insurance and maternity benefits if sudden shocks are not to push informal workers into poverty.
Third, the instruments that have been most effective in reducing inequality in industrialised countries since around 1880 are progressive taxes on income, inheritance and property. India’s Union government barely captures under 8% of the workforce in income tax; it does not have an inheritance tax and has abolished its wealth tax.
Property taxation (the responsibility of which lies with local governments) remains grossly inadequate and captures a minuscule portion of potential revenue.
Thomas Piketty, a French economist, notes that progressive taxes on income and wealth were established in the US, major European countries and Japan by the early 20th century. The growing trade union movements as well as the Bolshevik Revolution in Russia had an effect on the elites of Europe and North America.
Piketty notes that in Europe between 1914 and 1980, the effective tax rate paid by the richest thousandth and ten-thousandth was between 60-70%, or more than thrice the average rate. In India, on the flip side, 94 additional billionaires being added to Mumbai alone in 2023 should be an eye-opener!
While 1880-1980 saw a significant increase in the size of the state in industrialised countries, based on a rising tax-GDP ratio with rising income, India’s per capita has at least tripled in purchasing power parity terms since 1991, but India’s total tax-to-GDP ratio was and is still 17%.
Social expenditure
Fourth, public expenditure has been used in the now-rich countries to reduce inequalities in health, education and social protection.
The historical evidence over 100 years (1880–1980) on public expenditure is that the size of the state (measured by public expenditure/GDP) in Europe grew almost monotonically over a hundred years.
Economist Peter Lindert has demonstrated through his seminal work that the growing size of the state in the now-industrialised countries was entirely accounted for by social expenditure (i.e., health, education, social insurance, and social assistance). However, India’s current government has allowed public goods like health and education expenditure (as a share of GDP) to stagnate (health) or fall (education). Private goods (through ‘freebies’) are no substitute for public goods.
Finally, developing countries in particular suffer from inequalities based on ascribed identity (tribe, caste, race and gender). Reserved seats in education, Parliament and government jobs may be a good starting point but they will not solve the issue of representation.
As the Ecuadorian case — with no affirmative action and the lowest representation gap — proves, national organisation and mobilisation matter more at the national stage than set-asides.
India needs to start by making the Socio-Economic and Caste Census data public, updating it and then taking action to address the ascribed inequality.
India can reduce inequality by adopting all five methods.
(Santosh Mehrotra is a labour and human development economist)