India’s K-Shaped Economy: Why rich get richer and poor poorer
It’s 10.30 in the morning, and I am trying to focus on my writing. The pigeons are cooing outside on the verandah while the Mumbai Metropolitan Regional Development Authority (MMRDA) is busy banging away, probably digging another big hole. Or perhaps it’s the Mumbai Metro.
For a brighter tomorrow, one has to suffer noise pollution today.
In all this noise, I can hear a fishmonger trying to sell his wares, like he does this time of the day, every morning. A slum dweller is dragging a water cart along.
Today is like any other morning when I write the Easynomics newsletter. The difference is that after many years I am listening to Nazia Hassan sing aap jaisa koi meri zindagi main aaye to baat ban jaaye (If someone like you enters my life, then my life would be set) in her very soothing voice.
Music and taxes have been the only two constants in my life. Most other things keep changing. Friends come and go. Parents blow hot and cold. Cousins, who seemed close at one point, turn into individuals one can’t relate to. Cricket gets boring. Cooking becomes a chore. Books become too long. WhatsApp distracts all the time.
In all this, sometimes one does wonder what one is doing and is it worth it, given that everyone doesn’t have the option of settling in the hills or living on the beach or maybe simply doesn’t want to or can't afford it. But music and taxes keep me going.
And talking about taxes, we are in May, the second month of the current financial year. Between April and December, I work for myself. And from January to March, I work for the government, given that I pay a marginal rate of income tax of 30%. But, of course, I don’t just pay income tax, I also pay different indirect taxes, everything from excise duties to goods and services tax, in the price I pay to buy products and services I use.
So rough cut or mota moti as we would say in the part of the country I grew up in, I pay more than a third of my income as tax in different forms to the government. This means that I work for the government for almost four months a year.
Those in the higher income tax brackets work for the government for a longer duration than I do, and those in lower tax brackets or those just paying indirect taxes (and everyone pays that) work for the government for a lower duration than mine. So in that sense, all of us work for the government for a given duration every year. (Or alternatively, this explains why many well-paid Indians move to Dubai every year).
Working for the government for a given duration every year helps fill up its coffers. Like in 2021-22, the last financial year, the government earned Rs 27.07 trillion in taxes. This was 34% more than the total tax of Rs 20.27 trillion that the government had earned in 2020-21.
This increase was driven largely by a jump in direct taxes (corporate income tax and personal income tax) of 49%. On the other hand, indirect taxes (goods and services tax, union excise duties, customs duty etc.) grew by 20%.
Now compare this to the fact that the gross domestic product (GDP), or the measure of the size of the economy, is expected to grow by a little over 19% in 2021-22. This is in nominal terms without having adjusted for inflation.
So, what does this tell us? Tax collections have grown by 34% in an economy that has expanded by 19%. This works out to a buoyancy factor of 1.75. The buoyancy factor is obtained by dividing the growth in tax collections by the GDP growth. This means that for every 1% growth in the economy, represented by GDP growth, tax collections have grown by 1.75%.
A disclaimer needs to be made here. The 19% GDP growth forecast was made before the war in Ukraine broke out.
Hence, the chances are that the actual growth may turn out to be lower when it’s announced towards the end of this month. In that case, the buoyancy factor might be closer to 2.
Take a look at the following chart. It plots the buoyancy factor since the turn of the century.
(Click to expand)
The buoyancy of 1.75 is the second-highest since 2000-01. It was only higher in 2002-03, at 2.04. Of course, as explained earlier, the buoyancy factor might turn out to be closer to 2.
So, what does this mean? It means that tax collections for the government have grown much faster than the overall economy. As the government press release announcing the tax revenues collected said: “This revenue growth has been propelled by rapid economic recovery”. Of course, that’s true, but not totally true. It doesn’t fully explain why the economy grew by 19% and taxes much faster by 34%.
The press release further points out: “Various efforts were taken by tax administration on direct as well indirect taxes to nudge higher compliance through the use of technology and artificial intelligence.” Yes, again. But it still doesn’t tell us the full story.
What explains the huge jump in tax collections vis a vis economic growth is that one part of the economy is doing much better than other parts and hence, paying more taxes. As has been well documented, the informal sector, which was emerging from the ill effects of demonetization and a badly implemented goods and services tax, was hit by the covid-pandemic.
As Jahangir Aziz, chief emerging markets economist of JP Morgan wrote in a recent column in The Indian Express: “The domestic supply chain disruptions in manufacturing and services, especially at the informal level, haven’t been repaired fully.”
This has led to the increasing formalization of the economy, with larger companies taking over the business of smaller firms and gaining increasing pricing power in the process. Of course, this also implies many job losses in the informal sector.
Pranjul Bhandari, chief India economist of HSBC Securities and Capital Markets (India), wrote in a recent column in the Business Standard: “Small firms unable to withstand the sudden rise in input costs are closing, and the supply disruption is pushing up prices.” The increasing price power of large firms has led to higher profits, which has led to higher tax collections for the government.
Further, over the last two years, companies in the formal sector have cut costs rapidly and, in the process, pushed up profits and paid higher taxes. Of course, the cost-cutting has been borne down the line by everyone these companies outsource a part of their activities to.
When it comes to goods and services tax, an indirect tax, in a recent research report, Sumit Shekhar and Eashaan Nair, writing for Ambit Insights, suggest that the collections have been driven by high domestic inflation, the surge in imports due to higher international inflation and an “uptick in high-ticket consumption”.
When it comes to personal income tax, with the stock markets reaching new highs in 2021-22, the collection of the capital gains tax on stocks must have gone up as well, pushing up the overall direct tax collection. Notwithstanding the recent spurt of individuals investing in stocks, the well-to-do who were already invested in stocks must have ended up with a bulk of the gains.
At a broader-simplistic level, this points out towards a K-shaped economy, where different parts of the economy are facing different consequences from the negative effects of the covid-pandemic. Parts of it are doing well, and parts of it aren’t. Hence, the K-shape, with parts going up and parts going down.
In fact, this K-shape can be seen in the most unlikely of places. Take the case of life insurance policies bought by individuals. The total number of insurance policies sold by the Life Insurance Corp. (LIC) of India fell by 4.2% in 2020-21 from the previous fiscal. Interestingly, the total number of policies sold by private life insurers grew by 2.9%. This is because the private insurers sell insurance largely to the well-to-do section of the population with higher incomes.
On the other hand, the average LIC customer is poorer than the average customer of the private insurance companies. She is the quintessential aam aurat. And clearly, she is having problems buying an insurance policy.
In fact, this trend can also be seen in the average premiums paid by policyholders. In the case of LIC, the average premium paid on a policy (both old and new) in 2020-21 stood at Rs 12,651. This fell by 11% to Rs 11,260 in 2021-22 (April 2021 to December 2021). When it comes to private companies, the average premium paid in 2020-21 had stood at Rs 52,040. It fell by 0.7% in 2021-22 to Rs 51,676.
This again clearly shows how different parts of the economy have been impacted differently by the negative impact of the covid pandemic.
The ability to pay for the section of the population that buys policies from LIC has gone down much more than the section of the population that buys policies from private insurance companies.
Interestingly, examples of a K-shaped economy can be seen in other areas as well. Take a look at the following chart. It plots urban retail inflation and rural retail inflation since January 2019.
(Click to expand)
Rural inflation rarely goes above urban inflation, and if it does, it falls very quickly. But since the beginning of the year, rural inflation has been higher than urban inflation. One reason for this is the higher cost of lighting in rural areas. As economist Pranjul Bhandari explained: “The prices of kerosene used for lighting… are not regulated and have risen sharply.” In comparison, the price of electricity, which is the primary source of lighting in urban areas, has been largely flat over the past year.
In fact, this high inflation has been feeding into consumption. Take the case of Hindustan Unilever Ltd, a large, fast-moving consumer goods company. Its sales volume in the period January to March was flat. The volume is essentially defined as the sum of the unit number of each product sold by the company.
As Ritesh Tiwari, the chief financial officer of the company, said in a recent earnings call: “Almost 30% of our business comes from packs that operate at magic price points like Rs 1, Rs 5 or Rs 10. In these packs, our preferred mode of taking price increases is by reducing grammage. As a result, even the same number of units sold leads to volume decline.”
Again, Hindustan Unilever is a company which caters to the aam aurat, and the flat volumes suggest that inflation is shrinking household budgets. As Shekhar and Nair of Ambit put it: “Even as the overall private consumption in real terms is just 2% above the pre-pandemic level, the high-end consumption has performed well.” This is yet another example of the economy becoming more K-shaped.
Here’s one more example comparing domestic two-wheeler sales and car sales. According to the Federation of Automobile Dealers Associations (FADA), car sales rose 14.2% to 2.73 million units in 2021-22 from the previous year. The sales of high-end cars went up at an even faster pace. However, when it comes to two-wheelers sales, they went up just 3.8% to 11.97 million units. FADA measures the total number of vehicles registered at Road Transport Offices (RTOs) across the country.
In fact, according to the Society of Indian Automobile Manufacturers (SIAM), two-wheeler sales during 2021-22 fell by around 11% to 13.47 million units. For cars, sales rose by 11% to 3.01 million units. In fact, there was more demand for expensive cars but couldn’t be satisfied due to the global shortage of chips. SIAM measures the number of units of vehicles being despatched from factories to automobile distributors across the country.
Data from both SIAM and FADA gives us yet another example of a K-shaped economy and how the weaker section of the economy is struggling and the richer section continues to do well.
To conclude, in 1968, sociologists Robert K. Merton and Harriet Zuckerman came up with the concept of the Matthew Effect of accumulated advantage. The term takes its name from the Gospel of Matthew, which points out: “For to everyone who has will more be given, and he will have abundance; but from him who has not, even what he has will be taken away.”
In simpler terms, the Matthew Effect of accumulated advantage is stated as the rich become richer and the poor get poorer. This is how things have played out in the aftermath of the covid pandemic and the Ukraine war.
And this is where this newsletter ends. It’s around 1.35pm. The MMRDA guys are still at it, banging away to eternity. The pigeons continue to coo away. The heat and humidity persist, and so does the war in Ukraine. Nazia and her brother Zohaib are now singing ashanti ashanti composed by the legendary musician Biddu. And the disorder continues.