Why India need not worry about income inequality just yet.

A recent report by Oxfam International on Income inequality has captured everyone’s attention. It was designed to, published so close to the annual World Economic Forum summit in Davos. But i’m not here to tackle the report in its entirety. I’m here to tackle what the report says about India and why despite the obvious, and at times justified reaction of blaming the government for its poor economic policies, we need to have a more measured response.

What’s captured headlines across various news outlets in India is a small sliver of a very large report. News flashes such as, “INCOME INEQUALITY GETS WORSE; INDIA’s TOP 1% BAG 73% OF THE COUNTRY’s WEALTH, SAYS OXFAM” designed to essentially freak people out and increase hits. India’s media has a problem when it comes to conflicting and subjective reporting, but that’s not why we shouldn’t freak out. Income inequality has a lot to do with regulation, regulatory capture and rent seeking, but those are the things that you’ll see allocated the least blame. If regulation is mentioned, you’ll hear people advocating for increasing regulation, which in turn creates a more opaque system with such complexity that only those with the know how will profit. Responses to inequality usually range from tirades against globalization, immigration, and wall street. You might be perfectly entitled to allocate blame towards all three, but they don’t come close to having the effect rent seeking has had on inequality. It’s a topic that needs to be discussed at length until a solution is found.

Coming to India, the reason why we shouldn’t worry too much about the Oxfam report is the Kuznets curve. The Kuznets curve named after Nobel Prize winning economist Simon Kuznets, hypothesizes why high growth will lead to rising inequality at first, then flatten out, and eventually decrease in an inverted U shape trajectory. One explanation of the curve, involves investment opportunities that are primarily available to those with wealth during the initial phase of a developing economy and thus has a multiplier effect on the wealth for those who’ve already invested (a first mover’s advantage). The multiplier effect/first mover’s advantage is even more profound given the role inherited wealth plays in India. A majority of India’s top 1% have inherited their wealth from earlier generations, and thus a sizeable portion of their current wealth was created when India was in that initial phase of being a developing economy. The Second explanation takes into account the rural-urban divide you see when the center of an economy moves from rural areas (primarily agriculture based) to a more urban setting, where wages in rural areas decline as a result.

Kuznets curve

I must admit though, that Kuznets’ work has come under a lot of flak recently (Piketty), owing to rising inequality globally in developed economies. But as you’ve probably figured out, rather than call into question Kuznets work, I’m more inclined to blame rent seeking. Mostly, because the “scale” of rent seeking we see today in developed, and a few developing economies is unprecedented. Developing economies in question, consist of those where the beneficiaries of growth are oligarchs. The trends of increasing oligarchies and rent seeking weren’t as obvious in the 50’s, but Kuznets’ work has largely stood the test of time. So while you might see a lot of articles written in the next week blaming inequality on the government’s economic policies and the Prime Minister himself. Keep in mind, the rising inequality is at first, a natural progression and second, while India’s Gini coefficient (a measure of income distribution) rose from 45 to 51.4 in 2016, signaling an increase in income disparity between rich and poor. China’s Gini coefficient rose from 33 to 53 in the same period, an astounding figure even in absolute terms (and we know how much as Indians we love comparing ourselves to China). You might also see reports of how during the UPA years the gap wasn’t as wide, but if you take into account Kuznets work, that necessarily isn’t a good thing. It might just mean that during UPA’s second term, growth wasn’t high enough to cause an absolute rise in incomes for the wealthy. But growth wasn’t low enough for the wealthy to lose a massive chunk of it either, hence the stagnation. India most definitely came out better from the financial crises than most developed economies in relative terms, where one-third of the lower middle class/poor ended up with zero or negative wealth (Milanovic 2012), but that’s not something to pat ourselves on the back for. We still have a lot of work to do when it comes to fulfilling our potential, but inequality shouldn’t give us sleepless nights just yet.

One response

  1. […] Governments are even worse offenders. From the tax code comprising of 26000 pages in 1986 to 70000 pages to it’s so long nobody is sure how long it is. Regulatory growth isn’t far behind either, since 1980 regulatory growth has contributed to at least $4 trillion in less U.S. economic output, according to research by the Mercatus Center. To let that sink in, this amount is roughly equal to Germany’s economy, the size of the federal budget, and the combined economies of California and Texas. But, more importantly, it equals lost prosperity of roughly $13,000 for every person in America. The complexity surrounding our economic and financial institutions directly benefits rent seekers and indirectly hurts households. It’s also one of the major reasons for the rise in income inequality (I wrote about at length last year here). […]

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