BackInequality is bad for growth
Tackling inequality and inclusive growth is an economic necessity for the country
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After Pope Francis, it is now the turn of the International Monetary Fund (IMF) to raise concerns about high income inequality. Dubbed as “Francis the Marxist", for his tweet “Inequality is the root of social evil", the Pope has been raising issues of inequality and its consequences. The latest discussion paper by IMF not only supports the ethical and moral concerns of high inequality, but also goes on to give economic evidence that high inequality may actually be hurting growth. Coming from an institution which not so long ago projected the virtues of market and “trickle down" theory, the latest report has brought the issue of inequality back on its agenda.
In a nutshell, the report shows that an increase in the income share of the poor and middle classes by 1 percentage point raises growth by 0.38 percentage points in a country over five years. On the other hand, an increase in the income share of the rich by 1 percentage point reduces growth by 0.08 percentage points. These may be small numbers for a country growing at more than 7%, but they strike at the heart of the economic wisdom perpetuated by IMF about trickle-down theory, which argues that the benefits of growth trickle down to the poor. If at all, the evidence suggests a trickle-up rather than trickle-down effect.
As the report argues, a rising skill premium due to technical progress may be contributing to rising inequality in the developed world, whereas financial deepening as against financial inclusion may be contributing to rising inequality in emerging markets and developing countries. But a deeper concern that has been highlighted by the report is the reduced income mobility and exclusion of the poor from the growth process.
An interesting way to understand the relationship between inequality and social and economic mobility is the “The Great Gatsby Curve". Popularized by Anne Krueger (chairman of the Council of Economic Advisors to the US president) in 2012 in a presentation, it is a plot between income inequality and social mobility for a number of countries. Using data from labour economist Miles Corak, the chart plots the Gini coefficient of income inequality against the intergenerational income elasticity defined as the relationship between children’s income against their parents’. What the curve showed was that countries with high income inequality, such as the US, Brazil and China, had lower economic mobility compared with low inequality countries such as Denmark, Norway and Finland. In simple language it means that if you live in a country with high inequality, you are more likely to maintain your parents’ status in the economic hierarchy. Or in other words, your ability to escape poverty is lower in a country with high inequality than a country with low inequality.
And it is here that inequality becomes important. Not only because it slows down growth and thereby makes growth unsustainable in the medium-to-long run, but also because it is exclusionary. The low social mobility in high income inequality countries results from various factors such as the unequal access to education, health, nutrition or discrimination based on
non-economic attributes such as caste, gender and race. Some of these are also important factors in India and the failure of its high growth to translate into better human development outcomes is a reflection of deep-rooted social inequality.
So how does India measure up to all this? The measure of inequality in India is based on consumption expenditure and not income, which is what is generally used. But whatever limited information is available on income inequality from private household income surveys, India appears to be in the league of high income inequality countries. Unlike most emerging countries which saw inequality reduce or stay at the same level in the last two decades, in India even consumption inequality has steadily risen since 1993-94. However, the good news is that even though consumption inequality increased sharply between 1993-94 and 2004-05, it has now stabilized at the levels of 2004-05. Interestingly, the period after 2004-05 is also the period of the highest growth rates in India.
As the IMF report also suggests in its prescriptions, the best way to reduce inequality is to increase public expenditure not only on physical infrastructure, but also on health, nutrition, education and livelihood support, including social safety nets.
This, along with ensuring minimum wages, has been the key to bringing about sharp reductions in inequality in most Latin American economies, including Brazil. After 2004-05, the Indian economy also saw increased public expenditure in the form of various entitlement-based schemes, such as the Mahatma Gandhi National Rural Employment Guarantee Scheme. Not only was it important for maintaining demand in rural areas and thereby boosting growth, it also ensured that a large number of people living in rural areas were part of this growth.
It is here that the inaction and ignorance of the Indian government is baffling. Rural areas are currently going through stress because of falling commodity prices, stagnation in wages, and unseasonal and deficient rains leading to a collapse of rural demand. Reviving rural demand is important not just to ensure that the rural population is protected from these vulnerabilities, but also to restore economic growth to the earlier levels. At least, that is the message that one gets from IMF. Certainly, tackling inequality and inclusive growth is no longer a moral and philosophical argument coming from Pope Francis. It is also an economic necessity for the country.
Himanshu is an associate professor at Jawaharlal Nehru University and visiting fellow at Centre de Sciences Humaines, New Delhi.
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