Opinion | The quest for inclusive growth to combat inequality4 min read . Updated: 13 Sep 2019, 12:49 AM IST
The promise of equitable and inclusive economic growth has remained elusive, and the work of Thomas Piketty has shown that inequality worsened sharply over the past four decades.
The work of the World Inequality Lab led by French economist Thomas Piketty, author of the famous 2013 book Capital In The Twenty-First Century, documents a rather remarkable fact. In the nearly 90 years between the Great Depression of 1929 and the year 2017, inequality in the US and UK first collapsed enormously and then exploded, ending up roughly where it started. In 1928, at the end of the Roaring Twenties, 22% of the US national income went to the richest 1%. In 1979, that number had fallen to about half as much. In 2017, that ratio was back to more or less what it was in 1929. Something very similar happened in the UK. The share of the top 1% fell steadily from 1920 to about 1979 and then went up, almost reaching the 1920 levels by 2017.
India has followed an even more extreme trajectory than the US, at least since Independence. In the 1950s, the share of the top 1% in income was between 12% and 14%. That number dropped to 6% in the early 1980s and then began to climb, reaching 23% in 2017, which is comparable to the US.
Lest you assume that this is the inevitable trajectory that all market economies have to take, the share of the top 1% in France, Germany, Switzerland, Sweden, the Netherlands and Denmark was not too different from that in the US or UK in 1920. However, sometime after 1920, inequality went down very sharply in all of these countries. While there may be ups and downs, it remains very low by US standards.
What might account for these rather disparate trajectories? One idea that economists often come back to is that inequality is the cost we pay for fast growth. Cross-country comparisons are always fraught, as countries are different in so many different ways such as in terms of education systems, attitudes towards women’s work and the willingness to absorb new migrants, and inequality is just one of them. Nevertheless, it is striking to see just how closely the UK and France track each other in terms of gross domestic product (GDP) per capita between 1980 and 2018, despite their radically different experiences with respect to inequality.
In fact, across the world, the correlation between inequality and growth at the country level is negative—more unequal countries grow less fast, though there is no way to say that this is because they are more unequal. There is also no evidence that an increase in inequality is followed by increased growth.
Indeed, there is also very little support for the underlying theory that we need to incentivize the rich so that the country grows. The sharp turnaround in inequality in the US and UK around 1980 coincides with Ronald Reagan coming to power as president in the US and Margaret Thatcher as prime minister in the UK. They were both true believers in the doctrine of incentives above all, and pushed through a policy package that combined large tax cuts for the rich with massive deregulation, and hostility towards the rights of workers. This tectonic shift in attitudes did not happen in the rest of Western Europe, and it may be one important reason why they never saw the same explosion of inequality but did not really suffer in terms of growth. While this was not known in 1980, one of the important takeaways from the last 15 years of careful empirical research is that tax cuts and other giveaways to the rich do little to change their behaviour.
This is not to say that we should not worry about government overreach. It is clear that the dirigisme that we had in India before 1991 or China before 1979, or the complete disregard for macroeconomic rationality that we saw in Venezuela a few years ago can be debilitating. Governments do need to get out of the way of private businesses, but there is a lot that can be done with a simple set of instruments—sensibly high taxes on high incomes and high wealth, vigilance against resource grabs (land, mines, water) by the rich, progressive carbon taxes, and an effective defence of workers’ rights, not by making firing impossible, but by making job losses less painful.
It is clear that income inequality is an enormous and complex challenge. The level of inequality today, both in India and in countries such as the US and UK, is the highest it has been in the last 100 years and has increased steadily over the last several decades. The promise of equitable and inclusive economic growth has remained elusive, but giving up is not an option.
The generation of students graduating today must in their lifetimes continue the quest for this holy grail. They must understand that any attempt to solve the problem of inequality must be all-encompassing by nature. It is not a matter of economics and policy alone, but also that of attitudes, empathy and activism, both at the individual and societal level. It requires understanding the evidence about where things are going wrong and reacting to it intelligently, and making policy choices that are both sensible and innovative.
Most importantly, we must recognize that this is not a problem that can be solved in three or five years. We, and especially the young who are our future, must brace for this long quest with consistent purpose for the decades to come.
Kapil Viswanathan & Abhijit Banerjee are, respectively, vice-chairman of Krea University, and professor of economics at MIT