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Can India Break Out of the Inequality Trap?

 

james crabtree is an associate professor of practice at the Lee Kuan Yew School of Public Policy at the National University of Singapore and a former Mumbai bureau chief for the Financial Times. He is author of The Billionaire Raj: A Journey Through India’s New Gilded Age (Penguin Random House).

Published July 31, 2018

 

Dressed in an elegant black suit, Indian Prime Minister Narendra Modi stood up in January this year at Davos, the annual meeting of the World Economic Forum, and launched a spirited defense of globalization. Twelve months earlier on the same stage, China’s Xi Jinping had painted himself as an improbable new custodian of the global order, ready to defend free trade and spread open markets. Now Modi, the first Indian leader to lecture at the elite Swiss gathering for more than 20 years, attempted to repeat the trick.


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Speaking in Hindi, he described India as an enemy of protectionism and friend to international investors. Yet he still devoted much of his speech to defending his own record in office — and, in particular, his claim to have married economic growth with social progress. “The biggest reason for fractures within countries is inequality and disparity, leading to division and distrust,” he asserted. “I have always said that development should be inclusive and encompassing. We have tried in our own way to bridge the income and opportunity divide.”

It’s hardly surprising that India’s prime minister would claim his country as a model of inclusive growth. Having taken power in a thumping victory at the polls in 2014, Modi’s center-right Bharatiya Janata Party, or BJP, faces a tough re-election battle next year. While he is widely expected to win, his prospects turn on the credibility of his claim to have delivered more jobs and greater prosperity to India’s 1.3 billion people. Yet by Modi’s chosen measure of inequality, India is moving in the wrong direction.

This certainly fits with casual observation. Any traveler landing in Mumbai or New Delhi is likely to draw that sad conclusion simply from the ride from the airport. India has long been a highly stratified society, with divisions between its religions and castes, villages and cities, as well as between the richer and more industrialized south and west and more backward north and east.

Yet beginning around 1980 and gaining momentum in the aftermath of a balance of payment crisis in 1991, the country launched a series of economic reforms designed to push aside decades of socialist planning and isolation from the global economy. The positive effects of this change are written in the statistics. This year, India will be the world’s fastest-growing large nation — its $2.6 trillion economy (measured at current exchange rates) recently overtook France to become the planet’s sixth-largest. Measured by the more relevant terms of purchasing power, India’s GDP reached $9.5 trillion, making it the third-largest in the world, behind only the United States and China.

But there’s a big catch. The pace of that expansion has left India more divided by income and wealth than either of its two larger global rivals, and on a par with notoriously unequal nations like Brazil and South Africa.

The Face-Off Between Inequality and Growth

India’s new inequality is underpinned by contradictions. On the one hand, the country’s rapid growth in recent decades has lifted hundreds of millions out of poverty. Though India remains a poor country, with a GDP per capita less than one-seventh that of the United States in terms of purchasing power, social indicators from life expectancy to disease prevention have improved rapidly. It’s all too clear that reducing inequality by returning to anything like the supposedly egalitarian socialist system that dominated the country in the decades following independence in 1947 would be disastrous. But it is equally clear that simply maintaining the status quo won’t cut it either. India needs a new economic model, one capable of delivering the kind of inclusive growth Modi claims to support.

Few countries have managed to move quickly from poverty to middle-income status and beyond. Almost all those success stories have been in East Asia — first in Japan, then Taiwan, Singapore, Hong Kong and South Korea, and soon, perhaps, China. All followed roughly the same path. Step one was reform of agriculture, allowing free-market incentives to drive productivity growth. Next came export-focused manufacturing, which generated factory jobs and absorbed much of the rural labor made redundant by rapid changes in the farm economy. Labor-intensive manufacturing then provided an industrial base upon which more advanced, productive sectors could develop. Happily, the benefits of trade and global integration were generally shared broadly, in part because East Asian governments began to build rudimentary social safety nets in education and health.

Since 1991, India has struggled to mimic that model with only modest success. Its farm sector is vast and, for the most part, inefficient. The economy excels at some services, such as software, that take advantage of cheap digital communications and the high quality of the country’s elite education. But its manufacturing remains puny and uncompetitive in global markets despite Modi’s best efforts to tempt multinationals to use India as an export base.

Equally important, it has failed to develop the bedrock state services — education, health, transportation — that underpinned East Asia’s rapid egalitarian growth. As a result, the spoils of India’s increasing integration with the global economy have been enjoyed disproportionately by the already-prosperous. Without a change in public policy, there is considerable risk these trends will not only not improve, but will worsen. As the history of countries like Argentina and Brazil make clear, inequality that entrenches early in a country’s development becomes ever more difficult to reverse as the affluent lock the doors behind them.

 
The spoils of India’s increasing integration into the global economy have been enjoyed disproportionately by the already-prosperous. And without a change in public policy, there is considerable risk that these trends will not only not improve but worsen.
 
Reuters/Danish Siddiqui
 
Measuring Inequality

You probably believe that inequality had risen across the world over recent decades. You would for the most part be wrong. In 2016, the World Bank published Poverty and Shared Prosperity: Taking on Inequality, a report examining two centuries of global income distribution. It documents that the gap between the world’s rich and poor gradually narrowed after 1990 for the first time since the Industrial Revolution.

“This unprecedented drop in global inequality was driven by a convergence in average incomes across countries that was spurred by rising incomes in populous countries such as China and India,” the report explained. Put another way, if you treated all the world’s people as living in a single country, the gap between the poorest and richest among them has begun to narrow, driven by the new prosperity in Asia.

This unexpected finding hides two conflicting patterns, however — the first measuring inequality globally and the second involving the gap between the rich and poor within individual countries. And while the former was narrowing, explaining the overall trend, within-country inequality was widening. And here, India stands out as an especially stark offender.

Serge Attal/visum/redux

Prior to Modi’s speech at Davos, development charity Oxfam estimated that nearly three-quarters of Indian wealth generated in the previous 12 months had been gobbled up by its top 1 percent. The charity’s claim drew on more substantial research from investment bank Credit Suisse, whose 2017 Global Wealth Report found that the richest tenth of Indians held nearly three-quarters of its wealth – a higher proportion than in any other Asian economy. What’s more, the richest of the rich seem to be pulling away: India is home to over 100 billionaires (in US dollars), more than in any country except the United States, China and oligarch-riddled Russia. “The billionaire boom is not a sign of a thriving economy but a symptom of a failing economic system,” lamented Nisha Agrawal, chief executive officer of Oxfam.

While the rise of India’s super-rich is impossible to ignore, their fortunes alone don’t explain the degree or growth of inequality. But it is easy enough to document the expanding breadth of India’s social divide. India’s score on the Gini index — a measure of inequality where 0 means total equality and 100 total inequality — rose from 45 in 1990 to 51 in 2013, a level common in Latin America but far above other Asian economies, including Japan and South Korea.

Perhaps the most compelling research came last year in a paper by Thomas Piketty, the French economist who is widely known for sounding the alarm on the modern historical relationship between economic growth and inequality. Working with co-author Lucas Chancel, Piketty reconstructed income distribution from tax records to show that the share of national income taken by India’s top 1 percent was at its highest level since records began to be collected under the British Raj in 1922.

The same data showed a host of alarming trends. The richest tenth of Indians now hold 56 percent of national wealth, up from around a third in the early 1980s. That’s a higher proportion than anywhere except the Middle East, the world’s most unequal region. Meanwhile, the country’s middle classes — as defined by the next 40 percent of income earners — saw their share of the pie decline from around 45 percent to around 30 percent.

To be sure, India’s growing wealth gap is paralleled in many other countries, including China. But almost nowhere has this divergence in the fortunes of the wealthiest and the middle class been as sharp and as rapid as in India.

The Pushback

The extent of India’s new inequality has taken time to sink in, and many still dispute its dimensions and significance. This is partly a hangover from decades of socialism, which left the country poor but relatively equal by the standard of richer nations. It also reflects differences in what we mean by inequality, as well as whether one is examining inequality of consumption, income or wealth. Historically, India’s government focused on consumption, as might be expected in a country overwhelmed by the task of feeding, sheltering and clothing the very poor. But consumption measures have tended to place India mid-table in global inequality rankings, distracting attention from the far larger gap between rich and poor as measured by income and wealth.

 
Nearly three-quarters of Indian wealth generated in the previous twelve months had been gobbled up by its top 1 percent.
 

Other skeptics question the validity of the research on which claims about widening inequality have been based. Swaminatha Aiyar, a pro-market economist and commentator, points out that Piketty’s use of tax-collection data could underplay colonial-era inequality levels. “In 1922, over 40 percent of India was ruled by 500-odd princes, not the British,” he writes. “The princes and their nobility were enormously wealthy, but not subject to British taxes. Inequality in that era was surely much higher than today.”

In any case, Aiyar and others suggest that income inequality is the wrong yardstick by which to measure India’s progress. Piketty’s research, for instance, shows inequality falling during India’s socialist era between 1947 and roughly 1980, a period during which top income tax rates ranged above 90 percent and large swathes of the economy were nationalized. Yet for most Indians, living standards have been far higher in the post-reform decades. “While inequality certainly rose in the booming 2000s, 138 million people were lifted above the poverty line between 2004 and 2012, an Indian record,” Aiyar writes. “Inegalitarian liberalization accomplished what egalitarian socialism could not.”

Resistance to the idea of India as a nation of pervasive inequality also reflects a deeper intellectual division, epitomized in a longrunning argument between two of the country’s most respected economists, Jagdish Bhagwati and Amartya Sen. Bhagwati, a professor at Columbia University who is best known for his research on trade policy, began agitating for an end to India’s socialist experiment in the 1970s and provided the intellectual ballast for many of the free-market reforms that eventually followed. He has since been dogged in the defense of liberalization.

Bhagwati downplays worries about inequality, preferring to focus on the higher standard of living now enjoyed by India’s masses. He was also an early enthusiast for Modi, arguing that the politician’s economic successes as chief minister of the western state of Gujarat, with policies that promoted large-scale infrastructure investment and export-focused manufacturing, provided a template for the rest of the country.

Sen, a Nobel Prize winner and perhaps India’s most celebrated public intellectual, finds the proverbial water glass half-empty. He argues that, while the economic reopening has created a vibrant economy, growth has come at the cost of social development, especially at the bottom. Sen’s recent work, largely written with Belgian economist Jean Drèze, is sharply critical of India’s post-liberalization record. He notes that India has slipped behind neighboring Bangladesh on some basic measures of human development ranging from child nutrition to women’s health.

The duo argue this can be attributed to the failure to expand social services at an adequate pace, which has contributed to a growing imbalance between rich and poor. Sen shares Bhagwati’s enthusiasm for the tiger economies of East Asia, but mostly because they invested in core services like education while providing some social support to poorer workers as they moved from farms to factories and upward into the middle class.

This quarrel between Bhagwati and Sen has plowed on for the best part of a decade, making it hard to declare a victor. Since Modi’s arrival as prime minister, Bhagwati has been more influential, and his arguments have been used by reform advocates within the ruling BJP. Sen, by contrast, is critical of India’s prime minister, both for his economics and for his less-than-benign Hindu nationalism. Yet for all of their ferocity, the debate actually obscures a narrow intellectual consensus.

On the right, Bhagwati claims that achieving rapid rates of economic growth takes precedence over distribution issues. On the left, Sen emphasizes the plight of those at the bottom. For both, the size of the gap between rich and poor — the level of total inequality — has been secondary.

“Some critics of the huge social inequalities in India find something callous and uncouth in the self-centered lives and inward-looking preoccupations of a relatively prosperous minority,” Sen wrote in 2011. “My primary concern, however, is that the illusions generated by those distorted perceptions of prosperity may prevent India from bringing social deprivations into political focus.”

What Next?

For pragmatists, what matters now is how India might best move forward. Insight lies in the answers to three questions about India’s new inequality: What has caused it? Does it really matter if India’s rising tide is not carrying all boats? And, if it does, what changes in policy might begin to reverse it?

 
Sami Siva/redux
 
Research shows that heavily unequal nations tend to grow more slowly and are also more prone to financial instability.
 
Sunil Ghosh/hindustan times via Getty Images
 

The answer to the first rests on the market incentive-based model that India adopted after the government became committed to reform and requires a closer look at the collateral damage from otherwise positive changes. Dismantling the country’s old socialist state, for instance, reduced previously heavy taxes on individual and corporate income and helped to spur growth by increasing incentives to invest. But it also meant that a disproportionate share of the proceeds of growth flowed to the already wealthy.

Other factors have also played a role. New technologies tend to favor skilled workers over the unskilled, helping to boost the incomes of educated urbanites. Entrepreneurs with the capital and the knowledge to compete in globally connected industries like IT services have made fortunes for themselves and boosted the wages of those who had the skills to work for them. As a consequence, richer, business-friendly parts of India, such as the southern state of Kerala and cities including Bangalore and Hyderabad, have seen living standards pull away from the poor, largely rural heartland states of Bihar and Uttar Pradesh in the north.

Comparing India with China helps to see these changes more clearly. Chinese income inequality has risen over recent decades, although not as sharply as India’s. This is partly because China’s manufacturing-heavy economic model delivered rapid growth while raising living standards for those at the bottom of the income pyramid. In part, that was the result of creating large numbers of low-skilled jobs that paid better than scratching out a living as a rural laborer. But it was bolstered by heavy government investment in infrastructure and the beginnings of a social safety net.

As noted above, though, India’s new prosperity has mostly been enjoyed by the educated urban middle classes connected to the services sector. Only a tiny fraction of Indian workers hold formal jobs in these high-profile occupations, as demonstrated by the fact that only around 1 percent of workers pay income tax on their earnings.

Not everyone views this dynamic as problematic. Some economists argue that social divisions act as a spur to effort and innovation. Others lament the short-term consequences but suggest rising inequality is transitory, perhaps believing in the upbeat theory embodied in the “Kuznets curve,” named after Nobel Prize-winning economist Simon Kuznets. He hypothesized that inequality follows a predictable upside-down U-shaped progression, implying that countries become more unequal in early development, but a combination of economic, social and political factors combine to narrow the gap as they grow richer.

Studies in the aftermath of the global financial crisis, however, suggest that inequality begets stagnation. IMF research shows that heavily unequal nations tend to grow more slowly and are also more prone to financial instability. Countries with sharp economic divisions — for instance, between business elites and unskilled workers — also find it harder to create the sort of broad social accords that buttress support for structural economic reforms.

In India’s case, inequality also seems likely to be contributing to the relatively slow growth of a middle class, which remains much smaller in relative terms than in other emerging-market countries. There are related problems at the bottom, too. Although India’s poverty-reduction record over recent decades is impressive, tens of millions more could have been lifted from poverty had inequality itself not increased so sharply.

 
It will not be possible to fund a more inclusive safety net unless more revenue is found from the prosperous, embarrassingly few of whom pay income tax at all.
 

These trends affecting India have evolved over many decades, making it hard to hold any one government administration responsible. Certainly, the factors driving India’s new inequality predate Modi’s time in office. However, for all his talk about inclusive growth, Modi has done relatively little in his first term to stem that increase.

Piketty points out that dramatic reductions in inequality are rare and tend only to follow revolutions — events that force elites to accept that the rich should pay more tax and the poor should receive greater social support. Nonetheless, the French economist is highly critical of India’s political and business elite, which he claims has done little to develop policies that might hold back inequality’s rising tide.

As Modi heads for re-election next year, there are many measures he could push to make sure the fruits of prosperity are distributed more evenly — some of which would complement rather than conflict with the commitment to market-driven growth.

Creating the conditions for a Chinese-style manufacturing sector by streamlining red tape and reforming labor-market and land-acquisition laws is one important step, given the knock-on effect this could have for future industrial workers. During his first term, Modi did launch a high-profile campaign to promote export-oriented manufacturing but has little to show for it. It seems unlikely that India will be able to reproduce the kind of manufacturing boom that powered China’s rise, but even limited steps would help.

Growing inequality, though, is unlikely to be reversed without an expansion and improvement in basic state services. Thinkers like Sen are right to push for more funds for education, health and public pensions — all areas in which Modi’s government has promised much but delivered little. Nor, for that matter, will it be possible to fund a more inclusive safety net unless more revenue is collected from the prosperous, embarrassingly few of whom pay income tax at all.

Most fundamentally, the terms of India’s inequality debate must change. India need not choose between growth and greater equality. The success of East Asia, which invested in the social and economic infrastructure that increased mobility even as it fed labor and capital into the machinery of growth, shows what can be achieved. But to address the problems of its new inequality, it first needs to admit that it is real. If not, failure to protect Indian society from the collateral damage of breakneck growth will prove as counterproductive in future as the sclerotic socialism that stifled its development for so long.

 

main topic: Income Distribution
related topics: Asia