Illustration: Shyamal Banerjee/Mint
Illustration: Shyamal Banerjee/Mint

Inequality in India is far worse than believed

It's of Latin American rather than East Asian proportions. That is a problem

In his landmark budget speech in 1992, Manmohan Singh had said that the eventual aim of economic reforms was to encourage the growth of industries that use labour intensively, create jobs in the productive sectors of the economy and reduce income inequalities. He was clearly inspired by the success that many Asian countries had in the previous decades in pushing up average incomes without making inequality worse.

New data released in recent weeks shows that inequality in India is of Latin American rather than East Asian proportions. In its Asian regional economic outlook released last week, the International Monetary Fund (IMF) has put out new data that shows how the two most successful Asian economies after 1990—China and India—have seen inequality rise in tandem with economic growth. This is in sharp contrast to what happened in countries such as South Korea or Taiwan in earlier decades. The multilateral lender has based its analysis on the Gini coefficient, a standard measure used by economists to measure inequality.

The IMF estimates that the Gini coefficient for India has gone up from 45 in 1990 to 51 in 2013. China has done even worse. Its Gini coefficient has climbed from 33 to 53 in the same period. The IMF inequality estimates are very similar to the results from a new global study by the LIS Data Centre in Luxembourg, which has recently said that India has a Gini coefficient of 50. These numbers are far higher than the official estimates of inequality that are mistakenly based on consumption rather than income.

The inequality problem has to be understood properly if it has to be dealt with successfully. Too much of the Indian debate is dominated by either angry ideological battles or vacuous moralizing. There are several possible explanations for growing income inequality—from the nature of technological progress to the lack of opportunities due to the caste system, to ineffective government spending programmes and lack of infrastructure that connects people in the interiors to markets.

One important ingredient in this debate goes back to a link Singh made in his 1992 budget speech—the need for greater job creation in the modern sectors of the economy. This has been one of the few distinct failures amid the overall success of the economic reforms. The failure to create enough factory and office jobs has stymied the overdue shift of people from low productivity to high productivity work.

Inequality in India has two extra facets that deserve attention. First, there is difference in productivity growth between the urban and rural areas. Second, there is the income gap within the cities between those who have been able to connect to the global economy and those who have not. One practical illustration of this is the millions of farmers who remain trapped in a stagnant agricultural sector. Those who have managed to escape tend to eke out a living in tiny enterprises that have no access to formal credit, growing markets, technology or modern management, as the new Economic Census released by the government last month so starkly highlighted.

The countries of East Asia managed to evade this trap through labour-intensive industrialization that moved millions of poor people from farms to modern factories. The troublesome question is whether India can replicate this Lewisian transition at a time when robotics is changing the nature of industrial work.

The global picture is more pleasing to the eye. Global inequality has actually decreased since millions of Indians and Chinese began joining the global middle class from 1990 onwards. Lower global inequality is paradoxically a result of higher inequality in India and China.

Very high levels of inequality are bad in themselves. Harvard University economist Dani Rodrik has also argued that widening inequality can weaken public support for economic reforms, and thus encourage governments to choose populist policies. That is precisely what we saw with Manmohan Singh Ver 2.0—the prime minister of the two United Progressive Alliance governments rather than the finance minister of the P.V. Narasimha Rao government.

This is a lesson that the economic strategists around Narendra Modi should be sensitive to.

What policies should the government focus on to reduce inequality? Tell us at views@livemint.com

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