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ExplainSpeaking: Should India reverse economic reforms to reduce widening inequalities?

If inequality is still rising rapidly then it only implies that the government needs to bring in more economic reforms because such alarming levels of inequality could easily drag down the domestic growth story.

Written by Udit Misra , Edited by Explained Desk | New Delhi |
Updated: December 14, 2021 8:26:53 am
Labourers carry a load of vegetables at a wholesale market in Kolkata (AP)

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Dear Readers,

Last week, the World Inequality Report (WIR) 2022 was released and it created quite a stir. That’s because the report claimed that: “Contemporary global inequalities are close to early 20th century levels, at the peak of Western imperialism”.

What had led to these alarming results? The report, which has been authored by economist and co-director of the World Inequality Lab, Lucas Chancel, along with economists Thomas Piketty, Emmanuel Saez and Gabriel Zucman, blamed the policies of economic deregulation and liberalisation that have proliferated across the world (including India) since the 1980s.

“Income and wealth inequalities have been on the rise nearly everywhere since the 1980s, following a series of deregulation and liberalization programs which took different forms in different countries,” states the report.

It further goes on to say: “The rise (in inequality) has not been uniform: certain countries have experienced spectacular increases in inequality (including the US, Russia and India) while others (European countries and China) have experienced relatively smaller rises.”

It thus concludes that inequality is not inevitable but a “political choice”. In other words, if a government wants to address inequality it can do so by choosing to tax the rich and redistribute such wealth among the poor.

It also disputed the notion that higher economic growth typically brings with it higher inequalities, especially in the initial phase. “Average national incomes tell us little about inequality,” it stated. That’s because, according to the report, average national incomes are “poor predictors of inequality”. For instance, “among high-income countries, some are very unequal (such as the US), while others are relatively equal (e.g. Sweden). The same is true among low- and middle-income countries, with some exhibiting extreme inequality (e.g. Brazil and India), somewhat high levels (e.g. China) and moderate to relatively low levels (e.g. Malaysia, Uruguay).”

As a result, many of you must have read or heard several economic commentators berate economic liberalisation in the world — and especially India — and suggest that India or the world was much better off with the policy choices of the 1960s or 1970s etc.

Should India reverse the so-called economic reforms? Should the world do that?

Let’s look at the evidence from the World Inequality Report 2022 itself. The chart below is taken from the WIR 2022. It traces global income inequality between 1820 and 2020. This inequality is calculated by looking at the ratio — T10/B50 — the average income of the top 10% and the average income of the bottom 50%.

As can be seen in the chart, this ratio actually shot up between the 1960s and 1980s and, even more importantly, it has been coming down ever since. So while global income inequality is what it was during the peak of western imperialism, it is also true that income inequalities have been coming down since the 1980s.

Global income inequality between 1820 and 2020

Another chart, which breaks down what has been happening to the income share of the top 10%, the middle 40% and the bottom 50% also throws up similar results. As you can see, since 2000, the income share of the top 10% has been falling while that of the middle 40% has been rising at almost exactly the same pace.

These two charts, both of which are included in the executive summary of the report, weaken the case of anyone who says that the policies of economic liberalisation adopted since the 1980s per se were responsible for increasing inequalities.

Global income inequality between 1820 and 2020

It is also important in this context to look at what happened to poverty levels across the world and in India when economic liberalisation policies were being implemented in full swing.

Look at the chart below which gives the share of the world population living in abject poverty. As the slope of the graph shows, between 1980 and 2015, the share of the population living in abject poverty (that is, living at less than $1.9 a day) fell the sharpest during this phase.

Share of the world population living in abject poverty

The chart below shows that it is not just in percentages that abject poverty fell since the 1980s. The yellow arrow points to the year 1981 and it is clear that since then there has been a decline in the absolute number of people living in abject poverty.

Share of the world population living in extreme poverty, 1820 to 2015

The process of poverty reduction has been particularly swift for India and its neighbouring countries such as China and Bangladesh.

Look at the chart below which shows that the share of the population living in extreme poverty (less than international-$ 1.90 a day) in the world, India, China and Bangladesh. In India, this share has fallen from almost 60% to around 10%. In China, it has fallen from a whopping 89% to less than a percentage point.

Share of the world population living in extreme poverty, 1981 to 2019

The chart below shows that these trends of poverty reduction have not been limited to just the poorest. It shows how dramatically the share of the population that lived at less than international-$3.2 a day has fallen as well.

Share of population living on less than international-$3.2 a day

The chart below zooms in on India. It gives the share of the population on different income/poverty thresholds. As of 1981, only 13% of India’s population earned more than $3.2 a day. By 2017, this proportion was around 55%.

Share of the population on different income/poverty thresholds in India

What this data shows is that the same policies that many blame for widening economic inequalities in India are also responsible for the sharpest fall in abject poverty levels in the country and elsewhere.

The question to ask yourself is: “What would I prioritise: Reducing abject poverty levels or reducing inequalities?”

In other words, just because we want to reduce inequalities doesn’t mean we get rid of the economic reforms that have, by all accounts, brought down poverty levels sharply. Wanting to revert back to the policies of a time when India had lesser inequality because almost everyone was equally poor is akin to throwing the baby out with the bathwater.

The average annual national income of the Indian adult population is Rs 2,04,200 in 2021.

If inequality is still rising rapidly then it only implies that the government needs to bring in more economic reforms because such alarming levels of inequality could easily drag down the domestic growth story.

What could such reforms be?

A 2015 publication titled “In It Together: Why Less Inequality Benefits All” by the Organisation for Economic Co-operation and Development (OECD) throws some pointers.

* Greater role for women in the economy: “Governments need to pursue policies to eliminate the unequal treatment of men and women in the labour market and to remove barriers to female employment and career progression. This includes measures for increasing the earnings potential of women on low salaries and to address the glass ceiling,” it states.

This is particularly true for India which has one of the lowest female labour force participation rates. One way to improve women’s participation in the economy is to improve the law and order situation. The second is to invest in public transport. The third is to invest in their education. The list is long.

* Employment promotion and good-quality jobs: “Policies need to emphasise access to jobs and labour market integration. The focus must be on policies for the quantity and quality of jobs; jobs that offer career and investment possibilities; jobs that are stepping stones rather than dead ends”.

* Skills and education: More must be done to provide youth with the skills they need to get a good start in the labour market. With a rapidly evolving economy, further efforts, with the close involvement of business and unions, should be made in promoting a continuous up-grading of skills during the working life.

* Tax-and-transfer systems for efficient redistribution: “Adequately designed redistribution via taxes and transfers is a powerful instrument to contribute to more equality and more growth. In recent decades, the effectiveness of redistribution weakened in many countries due to working-age benefits not keeping pace with real wages and taxes becoming less progressive. Policies need to ensure that wealthier individuals and multinational firms pay their share of the tax burden. Large and persistent losses of low-income groups underline the need for well-designed income-support policies and counter-cyclical social spending”.

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A crucial bit here for India is to reform its tax administration system. In their excellent book titled “In service of the Republic”, Ajay Shah and Vijay Kelkar write that “The marginal cost of public funds in India is high. The cost imposed upon the economy for Rs 1 of public expenditure is Rs 3.” If our tax administration system is more effective it will be able to raise more money from the same tax base. If our expenditure machinery is more efficient, that extra tax revenue money will be better spent.

Share with me what you think India should do to reduce inequalities without necessarily reverting back to failed policies. Write to me on Udit.Misra @expressindia.com

Stay safe

Udit

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