Rising Income Inequality in India: Understanding Inequality Through Kuznets Curve

Income Inequality in the developing world is commonly observed and often shrugged off as a consequence of the structural changes taking place in these countries. India is a case in point for the same, post India’s revolutionary 1991 reforms- when the country opened its economy to FDI, relaxed international trade restrictions, and stimulated private sector growth- income inequality along with wealth increased in the state.


As India embraced the ‘Washington Consensus’ by reducing state involvement in the economy, its Gross Domestic Product rose considerably. India’s growth rates surged substantially, from 1991 to 1996, the average annual GDP expansion was 6.7%. Notwithstanding moderation, India maintained a real GDP growth rate of around 8.7% per annum between 2003-2007 thus earning the title of the fastest-growing economy in the world.


Post the 2008 crisis, India’s growth slowed down reaching a low point of 5.6% in 2012. The economy began recovering from 2013-14 onwards, up until 2016-17- when the growth rates decelerated again mostly due to policies like demonetization and the flawed implementation of the Goods and Services Tax. Throughout such fluctuations, India remained one of the world’s fastest-growing economies.


However, the domestic changes in income distribution were not reflected in these high growth rate projections. While absolute poverty decreased post-1991 in the country, levels of income inequality and relative poverty grew.

Source: World Inequality Database Working Paper- Indian income inequality, 1922-2015:

From British Raj to Billionaire Raj?


Despite high rates of urbanization and the service sector boom, the rates of income inequality (especially in urban areas) continued to mount. The boons of the 1991 reforms seem to have been borne only by a section of the Indian society. For example, during the first-decade post-reforms, indebted farm households nearly doubled, from 26% to 48.6% while the number of Indian dollar billionaires increased from 13 to 111 between 2004-15. One reason for this was, the government cutting back on welfare programs and the provision of subsidies- in a country that was still very much agrarian and rural. This change in government policy too was a part of the Washington Consensus model of economic growth. Eventually, due to lobbying and pressure from the communist parties in India, the government launched flagship mass social security schemes like NREGA and passed the National Food Security Act, but inequality continued to rise.


Here’s why this alarming rise in inequality was not acknowledged as alarming for a long period, the ‘Kuznets Curve’ view of the world suggests that income inequality is bound to grow as per capita income rises- but only till a certain threshold, beyond this threshold inequality is predicted to decrease. The Kuznets Curve, a theory developed by Simon Kuznets, essentially depicts the cost of economic development in its early stages. The curve, an inverted U, depicts the relationship between inequality and per capita income. The ultimate implication of the Kuznets Curve is that eventually, past a certain stage of economic growth, the costs associated with growth (rising inequality) reduce and the boons outweigh the banes. Therefore, observing increasing inequality in countries experiencing industrialization and structural changes is common. The theory states that as the rate of industrialization in the country quickens, per capita income will increase and the country will move into the second phase of the Kuznets curve where inequality stabilises. The increase in per capita income is also facilitated by urbanization and rural-urban migration which equalizes wage rates between rural and urban areas. After the economy passes the second phase and incomes increase further, the welfare state will kick in and inequality levels will begin to decline- presumably, through the efforts of the welfare state.

However, Kuznets theory has also been subject to criticism due to its lack of empirical evidence and external validity.


In India’s case, around 30 years after its liberalization reforms, inequality continues to rise. Referencing Kuznets theory we may argue that this is due to the fact that India is still largely an agrarian economy and hence it has not transitioned into the next phase of Kuznets theory yet. However, an important nuance is missing from this argument- high inequality levels often retard growth in countries. This may significantly prolong the country’s efforts to move out of the first phase of the Kuznets curve. Moreover, structural and cultural reasons also play a part in determining when inequality in the country can stabilize- often irrespective of income levels. To illustrate this better, we can observe the following experience from the Indian and Chinese economies-


In 1990, the top 1% population in India captured 11% of the National Income while in 2019 the top 1% captured 21% of the National Income. Meanwhile, China’s top 1% owned 8% of the National Income in 1990 which rose to 14% in 2019. As both countries adopted liberal reforms around the same period, their growth and inequality trajectories were similar through the 1990s and 2000s. However, China was eventually able to stabilize its inequality levels while India’s income inequalities continue to rise. The World Inequality Lab’s report on Income Inequality in Asia (2020) suggested that the cause for the same was the active pursuit of poverty-eradication national policies. China was able to deal with the country’s rising poverty levels faster and hence the rise in income inequality in the country was lower than it was in India. The lower levels of inequality in China also strengthen their growth rates.

Hence, national economic policies have a considerable role to play in decreasing inequality levels. This implies that simultaneous efforts in poverty eradication are required, even as the country passes through the first phase of the Kuznets curve. This is because the fall in inequality in an economy, after per capita income has increased beyond a threshold, cannot be expected to trickle down. That is, it is not the invisible hand (market forces) that reduces inequality levels in a country but active efforts of governments and state institutions. National economic policies guide the economy and are imperative in reducing inequality.


The Indian government on the other hand, while pursuing certain flagship welfare schemes, continues to focus on stimulating private-sector growth 30 years after regulations were liberalised. While state-sponsored stimulation of the private sector is not necessarily off target, the Indian government’s continued policy of reducing tax slabs (and ultimately abolishing them) for certain categories of businesses may be perceived as counterproductive to the aim of combating inequality through state-sponsored programmes. While one may perceive this as false-equivalence, it's important to consider that as the country’s fiscal deficits broaden and inequality levels (especially after the pandemic) continue to rise, such a step may not be considered wise. Moreover, repeated impact evaluations do not give much credit to the state-sponsored social security schemes in India. Hence, more focus and investments are required in executing larger and more effective social security schemes- especially if India wants to move out of its initial phase of growth soon.


References:

Further Readings:


To know more about India’s corporate taxation policies;


Written by- Riya Chaturvedi (riya.chaturvedi_ug21@ashoka.edu.in)