Budget 2023: Need to be inclusive to eradicate wealth inequality in India

India embarked on a trade and investment liberalisation-led economic growth model in 1991. These reforms came at a time when India was facing a balance of payment crisis with only $5.8 billion in foreign exchange reserves (1.3 months of imports), 12% inflation, and a fiscal deficit (% of GDP) of 9.4%. Largely driven by IMF's (International Monetary Fund) conditions for a bailout, the then finance minister Dr. Manmohan Singh presented a landmark budget in July 1991, ushering in a new dawn for the Indian economy.

GDP growth picked up from 1.1% in 1991 to an average growth rate of 5.9% between 1992-2000, 6.7% between 2001-10 and 5.1% between 2011-20 (6.4% between 2011-19). At the same time, GDP per capita grew from $304 in 1991 to $2,256 in 20212. Yet, there have been questions around widening inequality and poverty or in other words "quality of growth". India’s dismal 132 / 191 position in 2022 Human Development Index rankings reflects that GDP is not the only metric that should be used to measure growth, especially for an emerging economy like India where a significant part of the population is still below poverty.

Measuring Inequality

The share of the total wealth of the top 10% and bottom 50% was fairly constant between 1961 and 1981. However, wealth inequality increased significantly in the post-reform period. This is in line with the empirical regularity that initial phases of economic growth lead to an increase in inequality as established by Simon Kuznets (1971 Nobel Prize Winner). 

Similarly, India’s Gini Coefficient which measures income distribution has also increased from 31.7% in 1993 to 35.7% in 2019 signifying a growing income inequality. The share of top 10% in total income has increased from ~34% in 1991 to ~57% in 2021.

The growth in inequality that India has witnessed is majorly due to four reasons: (i) shift in earnings from labor to capital income, (ii) continuing over-dependence on agriculture, (iii) rapid growth of the services sector and (iii) decline in the rate of labour absorption during the reform period.

Measuring Poverty

According to poverty estimates by Planning Commission, national poverty has declined from ~45% in 1993-94 to ~22% in 2011-12. Therefore, while growth may have increased inequality, it has managed to reduce overall poverty level. 415 million people have exited poverty in the last 15 years which has led to a decline in the MPI (Multidimensional Poverty Index) measured by United Nations Development Programme (UNDP). The MPI measures poverty using two critical factors: (i) incidence of poverty (H) – proportion of people who are multi-dimensionally poor and (ii) intensity of poverty (A)- relates to number of deprivations (dimensions of poverty) that the poor are experiencing in the society.

However, the MPI data raises two critical concerns in India’s poverty eradication quest. Firstly, rural areas account for nearly 90% of total poor people in India and secondly, children are still the poorest age group – more than one in five children are poor vis-à-vis. one in seven adults. Therefore, the government needs to put special emphasis ongrowth of rural areas to avoid lop sided development that India has historically witnessed. As well as towards children welfare as this will directly impact the demographic dividend of the country in the years to come.

Will Wealth Redistribution Help?

Redistribution is often considered synonymous with cash transfers and wealth redistribution. While redistribution of wealth by imposing higher income and wealth taxes on the rich is one of the ways to reduce inequality but chasing only a wealth redistribution-based narrative will not make a lasting dent in poverty. Looking at what wealth redistribution will look like at a very high level -As of FY22, India’s billionaires’ wealth accounted for ~27% of GDP which translates to ~$1trillion of wealth. If this wealth is redistributed amongst the 229 million poor in India, every poor person would get ~$4,400 (₹350,000). The redistribution would be sufficient for ~21 years for the sustenance of these poor people which is only temporary support given that life expectancy in India is 70 years. Moreover, this kind of redistribution will prove counterproductive by taking capital away from the most productive thereby handicapping, and disincentivising them to contribute to the economy any further.

Ensuring A Sustainable Inclusive Growth

While taxing the rich is an important step in reducing inequality, it needs to happen in tandem with a growth-based narrative. Wealth creation is not a zero-sum game and the faster the pie expands through improved productivity, the better it is for everyone in the economy. Kuznets argued that the process of growth would lead to capital accumulation which would result in demand for labor thereby increasing wages. India needs to ensure that it starts investing in the poor so as to impart them with skills to improve labor absorption. 

Therefore, redistribution should not be merely of wealth but of opportunities like education, health care, micro-credit, water, energy etc. which will boost people’s capacity to generate income for themselves thereby serving as a more sustainable way of reducing inequality in the longer term. Instead of unconditional cash transfers, taxation of the wealthy should be used to finance access to these opportunities and provide a social safety net which is critical to prevent people from falling into poverty traps when adverse shocks hit. 

Investment in human capital and providing equal access to opportunities also opens doors for upward mobility– the upliftment of poor from one generation to the next. Similar to Kuznets theory, a new working paper by development research group of the World Bank has established aU-shaped relationship between relative intergenerational mobility and economic development. A society with high relative intergenerational mobility is one where an individual’s socioeconomic success is less dependent on the socioeconomic success of his or her parents. Based on the empirical findings of the paper, in the initial stages of economic development intergenerational mobility decreases as the variation in social class increases since the infrastructure needed to equalise opportunities is not yet affordable for all. India which currently has a GDP / capita of < $2,500 still falls on the left of the trough thereby resulting in rising inequality with economic development. Gradually, as national income increases further (beyond ~$5,000 / capita), countries tend to develop fiscal space necessary to fund the type of public interventions that gives children born into disadvantaged backgrounds the opportunities to fulfil their potential.  

 In India, the government has taken initiatives in the past to create employment opportunities for all especially with the MNREGA (Mahatma Gandhi National Rural Employment Guarantee Act) program launched in 2006. However, despite government’s tall claims, the program has been dying a slow death. The program which aims to provide 100 days of guaranteed employment to the rural poor was designed as a demand driven program but has turned out to be supply driven. Average person days of work generated has remained less than 50 across years. The is primarily due to factors like: (i) ridiculously low wages which is less than several state minimum wage rates, (ii) insufficient budget allocation to ensure proper implementation on the ground, (iii) payment delays, (iv) de-capacitated rural banks both in terms of staff and infrastructure to process wage withdrawals, (v) too much centralization weakening local governance, among others.

All the above reasons for failure of MNREGA point towards weak institutions and inadequate resources which have led to implementation pitfalls. Therefore India, currently at GDP per capita of $2,321, needs to grow to be able to develop the fiscal resilience and stronger institutions to provide equal opportunities for all. Hence the growth-based narrative cannot be ignored in India’s context. 

With the pre-budget meetings underway, one of the topics of discussion would definitely be around measures to revive growth amid a gloomy global outlook. This being the last full year budget before the general elections due in May 2024, it will be interesting to see how the government balances fiscal prudence and provides support for growth. 

However, with growth being the centrepiece of discussion, the government needs to givethought to how to make this growth more inclusive and amend the existing poverty alleviation schemes to make them more effective. Afterall, "we should measure the prosperity of a nation not by the number of millionaires but by the absence of poverty, the prevalence of health, the efficiency of public schools, and the number of people who can and do read worthwhile books" – William Edward Burghardt Du Bois.

(Ayush is an investment professional with Ares SSG Capital Management. Views are personal.)