Maitreesh Ghatak
Thomas Piketty’s 2014 book, Capital in the 21st Century, which documents the rise of sharp income inequality in the developed world since the 1970s, became an unlikely bestseller for an academic book dense with facts and figures. In a recent article with Lucas Chantel, Piketty has turned his gaze on India (‘Indian Income Inequality, 1922-2014: From British Raj to Billionaire Raj?’, goo.gl/gbPEde). Combining income-tax data with household surveys and national accounts, Piketty and Chantel track income inequality from 1922, when the income tax was introduced by the British colonial government, to 2014.
Leaving aside measurement issues, their key finding is that the share of the very rich in the national income, after falling steadily since the late 1930s to the late 1970s, started rising from the early 1980s and has steadily increased since then to reach a historical high in 2014, the latest year covered by their study. And, the share of the bottom half, as well as of those in the middle of the distribution, show the opposite pattern over the same time-period.
Thus, the authors conclude that top income shares were lower relative to the middle class and the poor in the 1950s to the 1970s due to “strong market regulations and high fiscal progressivity”, but this trend went the opposite way with the adoption of “pro-business policies” during the Rajiv Gandhi era, and continued with economic liberalisation. The authors do note their unwillingness to step into the old debate about the effect of reforms on poverty and inequality. But the way they frame their findings lends itself to the interpretation that low growth and government controls are good as they keep inequality down. Well, they do. They also keep average income levels down and more people below the poverty level.
Kuznets Curve
It was Simon Kuznets, who won the Nobel Prize in Economics in 1971, who first pointed out that economic growth leads to an increase in inequality at first, and then a decrease — the phenomenon being subsequently termed the ‘Kuznets curve’. In the early stages of development, those who are richer are better poised to take advantage of the new opportunities while an excess of supply of unskilled labour keeps average wages down.
Eventually, however, capital accumulation leads to an increase in demand for labour that pushes up wages. Also, the increasing role of human capital in production pushes up the returns from acquiring skills. All of this leads to an eventual decrease in inequality.
The part of Chantel and Piketty’s article that has received less attention, in fact, demonstrates this clearly: for the period when inequality was falling, the growth rate of average income was low, and the subsequent rise in inequality has been accompanied by high growth rates. However, the growth rates of the richest have been much higher than the growth rates of those in the middle, and certainly of those in the bottom half, and that explains the trend of inequality. It also demonstrates clearly the validity of the basic logic of Kuznets.
Bridge The Divide
It also highlights the importance of distinguishing between undesirable versus natural inequality. The former emerges because the rich are given more opportunities than the poor while the latter arises even when everyone is given good opportunities, due to differences in skill, effort, and enterprise.
Under the former, we have a class society where one’s background governs one’s opportunities while in the latter people have a reasonable chance of doing well independent of their origins. Cross-sectional inequality can arise in a system that creates more opportunities and, therefore, winners and losers. While the intergenerational persistence of inequality occurs due to unequal distribution of opportunities.
The focus of modern progressive policies should, therefore, be to create greater equality of opportunity, and not to restrict opportunities to equalise outcomes. Growth is not the enemy. Anytime someone criticises the increase in inequality that followed economic reforms, one should remember that 45% of the population was below the poverty line in the early ’90s. That percentage has gone down by almost half since, which means more than 100 million have moved above the poverty line. But before one gets a chance to get complacent, consider this fact: if instead of the income level that defines the poverty line, we take twice that value, even with three decades of relatively high growth, nearly 80% of the population is still below this threshold, which is striking given how stringently the poverty line is defined.
So yes, India has a major inequality problem, in terms of the distribution of gains of growth, reflecting differential opportunities. To tackle this, it needs a much greater investment in health and education, and much more of a conscious effort to create greater economic opportunities to help children from poor families experience upward mobility.
It also needs a much more conscious effort to bring the rich under the tax net. And, in particular, inheritance taxes, which go after the main source of inequality of opportunity —wealth.
(The writer is Professor, Economics, London School of Economics)
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