June 25, 2014

There could be a range of severity of implications of rising inequality, ranging from “discontent, disgruntlement and resignation to fate” at one extreme to a “near-French Revolution type situation” at the other. But that would be the ultimate, final outcome. In the process of reaching there, the fact will be that “rich will become richer” and it will be increasingly tougher for the not-so-rich to become wealthy soon. This will be because returns from assets will be higher than contribution of incremental GDP, and people owning means of production will be disproportionately rewarded. In fact, even new businesses may be funded or part-funded by such wealthy people, and hence, there could be a self-feeding cycle which will further increase inequality.

Challenges in tackling inequality

The key challenge is on the overall philosophy of tacking inequality – if the system is too socialist and equitable, it may discourage entrepreneurship and overall growth. If the system is too capitalist and outcome-oriented, then inequality will continue to rise. The American model comes closest to the optimal model, though inequality is increasing there as well – free, liberalised business environment for people to start businesses and plenty of jobs for others. However, the move from manufacturing to services and increase of efficiency has slowed down growth of meaningful jobs, and hence the outcome even there is getting lop-sided. In such times, the Government has to step in and effect some policy changes to balance the benefits of the system.

Taxation as a solution

Progressive taxation and Inheritance tax should be the instruments of the “near-last” resort as tools for reducing inequality. Such tools might discourage private enterprise itself, increase “loophole-lookout” and end up diverting wealth into unconventional assets. The right solution would be for the Government to give the direction and create policy frameworks to enable the reduction of inequality. “Equitable Growth” has to move from being a lofty maxim to percolating down at Industry level and Project level. Each Investment Project needs to gun for increasing GDP of the country, while doing something to ensure that it spreads the benefits over a larger population and society. Then only, the efforts will add up at a national level. Whether this will make Projects complex and slow down investments ? Probably! But in the long run, a slightly slower growth will be a small price to pay for a hugely equitable growth. And once, this becomes a way of doing things, even the speed of growth can be accelerated.

Indian situation

In one of the pieces in The Economist about a year back, I had read that the Gini co-efficient which is one of the measures of inequality has been increasing at an alarming pace in developed countries and even in China. But it has not grown as rapidly for India. As written in one of my Blog articles, there were a few contributing factors for that –

• India’s decision of not privatising sectors like Oil & gas, infrastructure,
• sustained reservations for backward classes,
• wealth re-distribution schemes like the income guarantee scheme for the poor,
• Food Security Acts, and
• Services sector contributing highly to GDP growth (being people-intensive vs being capital intensive).

However, we cannot be complacent from movement of the Gini in the past few decades, and need to keep a constant eye on rising inequality, especially as a new Growth-oriented Government has come to power, and we may yet repeat the mistakes of the West – we need to learn from them , grow fast, and leap-frog the intermediate phase completely.