Thoughts on the Indian Economy

Thinking about assorted economic issues in India.

Wednesday, April 26, 2006

Do we care about inequality?

India is, slowly but surely growing, and getting richer. According to the World Bank, the average GDP per capita in the period 1984-1994 grew 3.3% and in the period 1994-2004, it grew at 5.5%. The average per capita numbers are fine (remember-- population is growing too) but what the distribution of the income growth? That is, is everyone benefitting equally? According to two influential economist Angus Deaton and Jean Dreze, the answer is no. Based on their analysis of the data in the National Sample Survey, on the whole the number of people living below the poverty line went down. The rural poor declined 12.7% between 1987-2000 and urban poor declined by 10.5%. However, the ithis poverty reduction was marked by inequality. While in states like Haryana, Gujarat and Tamil Nadu the number of poor decreased by 11.3%, 12.4% and 14.1% respectively; West Bengal, Orissa and Andhra Pradesh saw a reduction of 3.2%, .5% and 3%. In Assam, the number of poor actually increased by .1%. The authors also say that in the nineties, agricultural wages grew by 2.5% whereas public wages grew by 5%. Deaton and Dreze say,
"The overall decline of poverty in the nineties does not rule out the possibility of impoverishment among specific regions or social groups. That possibility, of course, is not new, but it is worth asking whether its scope has expanded during the last decade. As the economy gives greater room to market forces, uncertainty and inequality often increase, possibly leading to enhanced economic insecurity among those who are not in a position to benefit from the new opportunities, or whose livelihoods are threatened by the changes in the economy. The increase of economic inequality in the nineties, noted earlier, suggests that tendencies of this kind may well be at work in India today."
The real question here is how much, if at all, should we worry about inequality of growth? If the average income in India is increasing and everyone is better off, does the distribution really matter? The Indian voters, who did not get a piece of "India Shining" certainly thought it did when, in 2004, they voted out the incumbent BJP government. Growth is good and inequality may be an inevitable consequence. The economist Simon Kuznets formulated the Kuznets curve which essentially says that there is a U-shaped relationship between income inequality and economic growth. That is, as poor countries grow, inequality first increases and then as they become wealthier, it decreases. In thinking about the rightful place of inequality in growth, let's first think about its roots.

One theory as to why economic growth has benefitted groups differently is that rates of return in certain sectors has been higher. The average annual growth rate in agriculture, manufacturing and services between 1994-2004 was 2%, 5.6% and 8.2%. Let's assume that people in the service sector were the ones who benefitted most from economic growth that is, the returns to their human capital were the greatest. Higher productivity of labor is a good thing and should be encouraged. Everyone will be worse off if the most productive aspect of the economy is suppressed to promote more equality.

The real question to ask when thinking about inequality is what is keeping people from building their human capital and moving to higher-growth sectors and ultimately, being better off? I believe this why the way to address inequality in India is not through highly redistributive measure which constrain market mechanism but to address the inequality in accessibility to education, health, gender inequality-- basic building blocks of human capital.

Abhirup Sarkar sums it up well:
"The question is, can the poor automatically take part in the emerging markets, and the answer is an unqualified no. In fact, the state needs to help them with education, skill formation, health services and other infrastructural facilities like roads, electricity, sanitation and so on before this wretched lot can participate in the market. For a proper economic development, therefore, we need both the market and the state. The market would create new possibilities and increase the demand for labour. The state, on the other hand, can partly take care of the supply side by making the poor market-worthy. One should not worry too much if in the process there is a little rise in inequality."


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