Rising inequality: indictment of economic liberalisation?

According to a recent research paper - 'Indian Income Inequality, 1922-2014: From British Raj to Billionaire Raj?' by the French economists Thomas Piketty and Lucas Chancel - income inequality in India has been growing sharply since the 1980s, which coincided with economic liberalisation and higher GDP growth rate. In other words, over the period of the 'licence permit raj', between 1951 and 1980, when India was growing at the so-called 'Hindu growth rate' of around 3.5%, income inequality was much lower.

In terms of numbers, the authors estimate that the share of the top 1% of income earners is currently at the highest level (22% of national income) since 1922 (the year Income Tax was introduced in British India) when a large part of India was ruled by super-rich Maharajas. This ratio went down to 6% in the early 1980s and has been steadily moving up thereafter. They further suggest that the share of the bottom 50% went up between 1951 and 1980 and has been going down since then. Should this be considered an indictment of economic liberalisation in India?

Piketty and Chancel use income tax filing data to estimate incomes of the top 10% while using household survey data to estimate incomes of the bottom 90%. There are problems of both under- and over-estimation. For example, the rich, apart from concealing true incomes from income tax authorities, also use various legal means such as using trusts and charities to transfer wealth and incomes; showing personal expenditures as company expenses; reinvesting profits in family-owned companies instead of declared dividends, etc., to show a much lower taxable income.

Similarly, in household surveys, the non-poor have an incentive to under-report income to avail of various subsidies and avoid getting caught in the tax net. Further, Piketty and Chancel estimate income inequality before taxes and transfers, whereas the more relevant concept is post-tax transfer inequality, which gives the outcome after taking into account redistributive fiscal correctives. The latter measure of inequality, in all likelihood, would be less than the Piketty-Chancel measure.

But even if we leave aside the methodological/statistical issues and accept that income inequality has increased during the period of economic liberalisation and higher growth rates, what should we conclude about economic policy? First, it is natural that with economic liberalisation and greater market opportunities, the already privileged and the rich would be better able to make use of the opportunities. As a result, both income and wealth inequalities would go up.

Nobel laureate Simon Kuznets observed this tendency, which has come to be known as Kuznets's 'Inverted U hypothesis', meaning income inequality goes up initially as countries go through the process of economic development and then comes down at a later stage.

Basically, with higher economic growth, inequality of both income and wealth goes up, while a large number of people are pulled out of poverty as some benefits of higher growth accrue to the poor in the form of additional job opportunities and pro-poor social welfare initiatives made possible by higher tax revenues. This has been the experience of both China and India, the two most populous countries in the world, in the post-liberalisation higher growth phases.

Further, the same tendency has been observed despite India and China having two vastly different political systems suggesting that, notwithstanding slogans and radical proposals, in reality nothing much can be done politically about rising inequalities. In fact, poverty reduction has taken place at a higher pace in the post-liberalisation era compared to the past in both the countries.

Also, China, growing at a higher rate than India for more than two decades, has been more successful in reducing poverty (defined in terms of some uniform international poverty line) but with higher income inequality than India. According to an IMF 2016 report, Income Gini Coefficient (a measure of deviation of income distribution from perfect equality) in India went up from 45 in 1990 to 51 in 2013 whereas it moved at a faster pace from 33 to 53 in China over the same period.

Opportunity gap

Differential opportunities, rather than outcomes in terms of income or wealth disparity, is a matter of bigger concern. That is why people from rural Bihar (with Consumption Gini of 0.17) go to urban Maharashtra (with Consumption Gini of 0.35) or, more generally, people migrate from less unequal rural areas to urban areas with greater inequality in search of more economic opportunities.

Dhirubhai Ambani (not his sons), Bill Gates, Mark Zuckerberg or Jack Ma amassed huge wealth in one generation by hard work and business acumen. So, the basic focus of policy should be to promote greater social and economic mobility by providing quality education, healthcare and other public services (like mass transit, power, digital connectivity and friendly environment for new entrepreneurs) to all.

People remain poor primarily because of lack of basic resources (land, finance and education/skills) and connectivity to markets. If the poor can be provided access to resources and markets, expanding income opportunities by economic liberalisation and higher growth would also benefit them, even if it may be accompanied by greater inequality in outcomes.

At the same time, the preferential tax treatment of capital income relative to wage/salary income on the ground of encouraging risk-taking has to end as it accelerates inequality over successive generations. A person earning from a mutual fund or index fund (and paying no tax) is not taking any greater risk of variability of income than the wage earner who lives under the ever-present probability of losing his job (for no fault of his) and earning zero income.

(The writer is a former Professor of Economics, IIM, Calcutta)