India’s Tryst with Trickle-Down Economics: Inequality vs. Growth

Every year a day before the budget is tabled in the parliament, the Ministry of Finance releases its flagship document, The Economic Survey. It offers detailed information about the Indian economy over the past year, the current state of the economy, and occasional insights into the economic outlook. It is considered to contain the most authoritative and updated data on India’s economy.


Prepared under the guidance of the Chief Economic Advisor (CEA), the Economic Survey also recommends policy changes to the government, which are, however, not binding but only act as a guide in framing national policies.


This year the Economic Survey themed “Saving Lives and Livelihood” was released on 29th January 2021, by CEA Krishnamurthy Subramanian. Focussed on the economic impact of the coronavirus pandemic, the survey predicts India to witness a V-shaped recovery and take 2 years to reach and go past the pre-pandemic level.


A V-shaped recovery describes the shape of the economic growth graph over a period of time. In it, the economy is predicted to bounce back from a downturn (or crisis) with no lasting impact on the growth pattern - growth continues on its earlier path with just a small hiccup in the way.


Source: Brookings Institution


Chapter 4 of the economic survey is of particular concern for this analysis. Titled “Inequality and Growth: Conflict or Convergence?” this chapter talks about the commentary over rising inequality in the advanced economies and juxtaposes it into the Indian context.



Trickle-down Economics and Inequality


This debate starts with the adoption of a ‘trickle-down' economics model adopted by Western nations in the middle of the 20th century. It came to be believed that a ‘rising tide lifts all boats’, that is, high economic growth would bring increasing wealth and higher standards of living for all sections of the society. In the 1950s and 60s, there was some evidence to back this claim – in the industrialized economies every group was advancing, and those with lower incomes were rising most rapidly.


The economic and political debate that followed led to the evolution of this ‘rising tide hypothesis’ into a much more specified idea, according to which policies that favoured the richer classes would invariably benefit everyone. Resources given to the rich would end up ‘trickling down’ to the rest of the population.


This idea was one of the foundations for the neoliberal revolution in the 1970s, heralded by Margaret Thatcher and Ronald Reagan. The United States and the United Kingdom witnessed massive tax cuts for the rich (the tax rates were reduced from 80-90% to 28% after the Reagan tax reform in 1986 in the United States), privatization, deregulation, outsourcing, crushing of trade unions, competition in public services such as healthcare and education, and reduction in public housing.


Figure 2: sevenoillarsinstitute.org


Proof that this approach does not work was exemplified during the 2008 Great Financial Crisis. Both President Bush and Obama adopted this ‘trickle-down’ strategy by giving huge sums of money to big banks in the hopes that they would restart lending and benefit everyone. It was argued that this strategy would be far more efficacious than helping individual homeowners, businesses, or workers directly. However, over 91% of the gains in income in the next 3 years went directly to the top 1%. The rescue plan worked in enriching those at the top while the rest waited for the benefits to trickle down.


Today, the United States of America is one of the most unequal nations in the world and wealth is even more concentrated than income. The top 1% of Americans hold over 30.4% of all household wealth, while the bottom 50% of the population holds just 1.9%.


The French economist Thomas Piketty, after years of research on the contradictions of capitalism, observes that inherited wealth grows faster than output and income – the rate of return on capital and wealth owned disproportionately by the richest (r) has always been higher than the rate of growth of the economy (g):


r > g


This means that inequality is a natural characteristic of the capitalist mode of production and is also perpetuated through the higher returns experienced on capital.


In his latest book, Capital and Ideology (2020), Piketty concludes that

"inequality is neither economic or technological, but ideological and political."

So, what does the Economic Survey say?


The Economic Survey of 2021 considers this commentary and concludes that since India has the potential for higher rates of growth than the Western economies and has a scope of uplifting millions out of poverty, it should continue to focus on economic growth by expanding the size of the overall pie, or by rising the tide.


The chapter concludes the following points:

  • The relationship between inequality and socio-economic outcomes, on the one hand, and economic growth and socio-economic outcomes, on the other hand, is different in India from that observed in advanced economies.

  • By examining the correlation of inequality and per-capita income with a range of socio-economic indicators, including health, education, life expectancy, infant mortality, birth and death rates, fertility rates, crime, drug usage and mental health, the Survey highlights that both economic growth – as reflected in the income per capita at the state level –and inequality have similar relationships with socio-economic indicators.

  • Unlike in advanced economies, economic growth and inequality converge in terms of their effects on socio-economic indicators in India.

  • Economic growth has a far greater impact on poverty alleviation than inequality.

  • Given India’s stage of development, India must continue to focus on economic growth to lift the poor out of poverty by expanding the overall pie.

  • Redistribution is only feasible in a developing economy if the size of the economic pie grows.


While these conclusions would lead one to believe that inequality is not necessarily bad for the economy, empirical research by IMF has shown that inequality is associated with economic instability. In particular, IMF researchers have shown that growth spells tend to be shorter when income inequality is high.


Empirical research released by OECD (Organisation for Economic Cooperation and Development) also shows that income inequality has a negative and statistically significant effect on the medium-term growth of economies. It estimates that in countries like the US, the UK and Italy overall economic growth would have been 6-9 percentage points higher in the last twenty years, had income inequality not risen.


Nobel laureate Joseph Stiglitz wrote about the different channels through which inequality harms the economy:

  1. Inequality leads to lower aggregate demand. This is simply because those with lower incomes spend a larger fraction of their income than those with high incomes, who tend to save more.

  2. Income and wealth inequality also leads to inequality in opportunities when citizens are not able to access the same quality of healthcare, education, or nutrition. This results in those at the bottom of the income distribution not living up to their potential, the economy pays a price not only with weaker demand today but also with lower growth in the future. This effect is more pronounced in India where people also experience ‘horizontal inequality’. The United Nations’ Human Development Report 2019 noted that those belonging to Scheduled Castes, Scheduled Tribes and Other Backward Classes underperformed the rest of the society across human development indicators, including education and access to digital technologies.

  3. Societies with greater inequality result in the rich having disproportionate influence over the workings of the government. According to Stiglitz, these societies are less likely to make public investments that enhance productivity, such as in public transportation, infrastructure, technology, and education. “If the rich believe that they don’t need these public facilities, and worry that a strong government which could increase the efficiency of the economy might at the same time use its powers to redistribute income and wealth, it is not surprising that public investment is lower in countries with higher inequality.”


India: COVID-19 and Inequality


Figure 3: Oxfamindia.org


When the Coronavirus first emerged and led to lockdowns, it was being touted as a great equaliser, however, it has laid bare the stark inequalities inherent in the society soon after the lockdowns were imposed and people start to bear the brunt economically.


As of January 2020, according to an Oxfam report, India's richest 1% of the population holds 42.5% of national wealth while the bottom 50%, the majority of the population, owns a mere 2.8%. This was the pre-pandemic period. Now, ever since March 2020 when India announced the world’s biggest COVID-19 lockdown and the economy came to a standstill, data has shown that 1,70,000 people lost their jobs every hour in April 2020, while the Indian billionaires have seen their wealth rise exponentially.


Figure 4: qz.com


Another report by Oxfam India titled “The Inequality Virus” released in January 2021, found that in India:

  • The rich got richer: The wealth of Indian billionaires increased by 35% during the lockdown.

  • Informal workers were worst hit: Out of a total 122 million who lost their jobs 75%, which accounts for 92 million jobs, were lost in the informal sector. The mass exodus on foot triggered by the sudden lockdown and the inhuman beating, disinfection and quarantine conditions the informal workers were subjected to turned a health emergency into a humanitarian crisis.

  • Education on hold: The long disruption of schooling risked doubling the rate of out of school, especially among the poor. Only 4% of rural households had a computer and less than 15% of rural households had an internet connection.

  • Health Inequalities: The government did take steps to make COVID-19 services affordable by including them under Ayushman Bharat-PMJAY, however, the scheme only covered the BPL population leaving out the uninsured poor and the Middle Class to fend for themselves in situations of exorbitant hospital bills.


Conclusion


While India is one of the fastest-growing economies in the world, it is also one of the most unequal countries. The rich are getting richer at a much faster pace while the poor are still struggling to earn a minimum wage and access quality education and healthcare services, which continue to suffer from chronic under-investment (in this years’ Budget, the education sector saw a staggering cut of over INR 6,000 crores).


The United Nations’ Human Development Report 2019 stated that country and regional case studies provide very little empirical support to the trickle-down hypothesis over recent decades.

“Higher-income growth at the top of the distribution is not correlated with higher growth at the bottom.”

The report added that national economic policies do matter and lower inequality levels can accelerate both poverty reduction and overall economic growth rates.

“Global inequality data shows that rising inequality is not a fatality and that countries with strong investments in public services and welfare policies have the lowest inequality levels. Tackling inequality is a matter of political choice.”

At this important juncture, where there is an opportunity to start over and other nations are aiming to make their economies more inclusive and sustainable – EU’s Recovery Fund focussing on sustainable development and Biden’s “Build Back Better” program, India’s preference for growth over inequality seems folly in the long-term and might prove detrimental for a majority of the population.


References:

The Inequality Virus—India Supplement 2021, Oxfam India https://www.oxfamindia.org/press-release/inequality-virus-india-supplement-2021

Rise In Inequality In India Second Only To Russia, Shows UN Report, BloombergQuint https://www.bloombergquint.com/business/income-inequality-in-india-rise-in-inequality-in-india-second-only-to-russia-shows-un-report

Economic Survey 2020-2021, Government of India https://www.indiabudget.gov.in/economicsurvey/

Inequality and Economic Growth by Joseph Stiglitz https://www8.gsb.columbia.edu/faculty/jstiglitz/sites/jstiglitz/files/Inequality%20and%20Economic%20Growth.pdf


Author:

Rishabh Ahuja is an undergraduate student of Cluster Innovation Centre, University of Delhi. He is interested in International Relations, Public Policy and Philosophy. E-mail ID: Ris.ahuja@ducic.ac.in