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Tuesday, May 11, 2021

ExplainSpeaking: Why saving the middle class is critical for India’s economy and its democracy

India's Economy 2021: In 2020, Covid disruption resulted in reducing India’s vibrant middle class by one-third. Can the government stem the slide?

Written by Udit Misra , Edited by Explained Desk | New Delhi |
Updated: April 22, 2021 9:26:39 am
Shoppers seen violating social distancing norms on the streets of Kolkata (Express photo/Shashi Ghosh)

Dear Readers,

There are two main reasons why the novel Coronavirus has been such a disaster for the world economy: One, that it infects everyone — regardless of their economic status, and two, because it essentially spreads just the way economic growth does — via human interaction. In other words, controlling the virus’ spread and limiting the damage on the health side necessarily, by definition, results in incurring economic losses.

While this was known from day one, this odious trade-off explains why so many governments and populations have been caught napping with more damaging second and third waves.

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India is no exception. But, unlike other countries such as China, which controlled the virus much sooner, or the US and the UK, which despite being hit hard by Covid had the financial resources to protect the livelihoods of their people, India has suffered grievously.

Starting April, it was expected that India’s economy will register a fast economic rebound and quickly make up for the losses incurred in 2020. But the massive and unabated surge in Covid cases all across the country, which has exposed the government’s lack of preparation over the past year as grossly inadequate, points to the possibility of a scenario where India may not even be able to make up for the economic (GDP) contraction it suffered in the last financial year (2020-21).

But what does it mean in real terms?

Such a sharp contraction in GDP growth essentially means that millions of people will not only lose part or all of their current incomes but also the means to earn their income. What’s worse, since India’s economy was already decelerating before the pandemic, people do not have the savings to fight for long. Sooner rather than later they will see a sharp worsening in their economic, physical and social wellbeing.

A lot of focus has been on the pitiable state of India’s migrant workforce, but there is an equally primal shriek of desperation being let out by India’s middle class — one which has largely gone unheard.

Last month, the US-based Pew Research Centre put out some exact numbers in this regard (see charts below).

“Prior to the pandemic, it was anticipated that 99 million people in India would belong in the global middle class in 2020. A year into the pandemic, this number is estimated to be 66 million, cut by a third. Meanwhile, the number of poor in India is projected to have reached 134 million, more than double the 59 million expected prior to the recession,” stated the Pew report.

While the fact that 75 million people will be pushed back to abject levels of poverty (of living at less than $2 a day), what is equally, if not more, worrisome is that fact that India’s middle class was reduced by one-third — and that is just the impact of the last year. Given its severity, the current second wave and its economic impact could well mean that India’s middle class will be reduced to half of what it was before the pandemic.

Source: PEW Research Centre

What exactly is the middle class?

Typically economic researchers tend to use income or expenditure (as a proxy for income) to spot the middle class. For instance, in the above case, the poor live on $2 or less daily, low income on $2.01-$10, middle income on $10.01-$20, upper-middle income on $20.01-$50 and high income on more than $50. But it is possible to define the middle class as those whose expenditure ranges between 75% to 125% of the median expenditures.

Further, cash is not the only marker of being middle class.

It is also characterised by certain values, mindsets, educational and occupational choices. For instance, people belonging to the middle-class aim to have decent well-paying jobs or small businesses, hope to own a house of their own, seek to have a secure retirement, and want to secure the healthcare and educational needs of their family. Every generation of a middle-class household hopes that its next-generation would be slightly better off.

Why does the middle-class matter?

Unlike its humble name, the middle class is often considered the glue that keeps modern liberal democratic economies from falling apart under the strain of ever-rising inequalities.

In his 1984 article in the New York Times, well-known political economist Lester Thurow said the shrinking of the American middle class was a “cause of concern for the American political democracy”. “What Karl Marx saw as an inevitable revolution was based on the assumption that the economy would eventually generate a bipolar income distribution composed of rich and poor. Once this bipolar situation existed, he said, the poor would revolt, destroy the rich, and establish communism. But Marx’s predicted revolution did not occur because he did not foresee the rise of the middle class. The middle class had an interest in preserving capitalism and voted to alleviate the worst excesses of capitalism with social welfare programs. Their very presence gave the poor hope that they too could escape from poverty,” he wrote.

Source: PEW Research Centre

Beyond the political aspect, it is now well established that economic growth is stronger in countries that have a strong middle class. A 2011 Asian Development Bank paper, titled “The Role of the Middle Class in Economic Development: What Do Cross-Country Data Show?” looked at no less than 72 developing countries, including India, to confirm the finding by researchers like Nobel winners Abhijit Banerjee and Esther Duflo and many others that middle class has a salutary impact through various ways. For instance, the middle class is where entrepreneurs that foster innovation and growth emerge. Middle class “values” also encourage the accumulation of human capital (via education) and savings (that can then be used for productive investment in the economy).

Moreover, in comparison to the poor, the middle class has the ability and power to demand better public service delivery and greater accountability from public officials, and support growth-oriented policies.

But the world over, the middle class has been shrinking and this trend is considered worrisome. “Among middle-class households, there is now a growing discontent with economic conditions. In this context, the stagnation of middle-class living standards in OECD countries has been accompanied in recent years by the emergence of new forms of nationalism, isolationism, populism and protectionism. Nationalistic and anti-globalization sentiments can arise because a shrinking middle class produces disillusionment and damages political engagement, or turns voters towards anti-establishment and protectionist policies. Political instability is an important channel through which a squeezed middle class may upset economic investment and growth,” states a 2019 OECD book, titled “Under Pressure: The Squeezed Middle Class”.

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In India, all the data pointed to the middle-class coming under severe strain even before the pandemic. Unemployment levels had risen to a 45-year high even as consumption expenditures had fallen sharply (although the latter survey was disowned by the government). Health and nutrition data also showed a significant decline even as educational outcomes continue to lag. National accounts data showed Indians getting more and more indebted since 2017. Further fuelling the middle-class discontent in recent years has been the high retail inflation especially led by heavy taxation on every fuel like petrol and LPG.

It was at this juncture that the Covid pandemic wreaked havoc.

So what can be done to remedy the situation?

The ADB paper concluded that “policies that factor in the welfare of the middle class and nurture their growth may be a more effective long-term strategy for alleviating poverty compared to policies focusing solely on the poor”.

That’s because a growth strategy that includes the middle class is likely to be more sustainable, given that more people across different racial and ethnic groups share in the growth process.
“A politically and economically strong middle class is more likely to hold a government accountable, which would, in turn, ensure the rule of law, protection of property rights, and continued economic reform,” it stated.

More specific to the Indian middle class, the starting point has to be a reordering of the taxation and benefits matrix. In other words, the overall tax burden should be reduced even as the benefits such as public healthcare — which has been exposed to be woefully inadequate — and education are ramped up. Doing this would necessarily require the government to make the tax system more progressive and demand higher taxation from the rich.

Similarly, the government must do everything it can to bring down the cost of living for the middle class. For instance, making housing affordable.

The third big thrust has to be to address the lack of jobs and falling labour force participation rate. In particular, this will require a concerted effort to improve the skills of India’s middle class.

Mask up and stay safe,

Udit

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