Inequality matters

Updated: Mar 5 2013, 08:04am hrs
Given the average GDP growth of 8.5% during FY05 to FY10, the Eleventh Plan target of reducing poverty by 2 percentage points a year was disappointing

Radhicka Kapoor

That poverty in India has declined between 2004-05 and 2009-10 is indisputable. Poverty estimates based on the Tendulkar poverty line released last year indicated that poverty headcount ratio declined by 8%, 4.8% and 5.7% in rural, urban and all-India, respectively, during this period. This worked out to an annual decline of 1.64% and 0.92% in rural and urban India, respectively. Given that the average growth rate of GDP during this period was about 8.5%, exceeding 9% in three of the five years, and that the Eleventh Plan aimed to reduce poverty by 2 percentage points a year, this pace of poverty reduction is indeed disappointing. If economic growth was the only factor that mattered for poverty reduction, we should have witnessed greater poverty reduction. Moreover, states with the highest growth rate should have performed the best in terms of poverty reduction. But state-wise poverty estimates indicate that this is not the case. For instance, Bihar and Chhattisgarh witnessed average growth rates of about 10% during this period, yet poverty declined by less than 1%.

While growth is unquestionably necessary for substantial poverty reduction, it appears that growth is getting weakly linked with poverty reduction. In other words, the growth elasticity of poverty (GEP) is not high enough. GEP gives the percentage change in a chosen poverty measure in response to a 1 percentage change in GDP or mean income and can be interpreted as the poverty reducing impact of growth. In the poverty literature, GEP is found to be a function of initial income distribution, and it has been shown that rising levels of inequality lower GEP. The rationale for this is that the higher the initial inequality, the lesser the poor will share in the gains from growth. Martin Ravallion explains this succinctly as: Unless there is a sufficient change in the distribution, people who have a larger initial share of the pie will tend to gain a larger share in the pies expansion.

The National Sample Survey (NSS) data point in the direction of rising inequality in India. The Gini coefficient for rural India increased from 0.27 to 0.28 between 2004-05 and 2009-10, with rural inequality rising in 11 states. The Gini coefficient for urban India increased from 0.35 to 0.37, with urban inequality increasing in 18 states. Moreover, the ratio of per capita income between the top 15% and bottom 15% of the population has risen from 3.9 to 5.8 in rural areas and from 6.4 to 7.8 in urban areas during this period. This indicates that not only is inequality between the two groups on the rise, but also that the benefits of economic growth have not trickled down to those at the bottom of the distribution. Importantly, this rising inequality has reduced GEP.

Moreover, these inequality measures need to be interpreted with caution as India measures inequality based on consumption rather than incomes, and consumption inequality tends to be lower than income inequality because of consumption smoothing by households. Also, the NSS estimates of consumption expenditure fail to capture the top income groups, thereby resulting in underestimation of inequality. Therefore, inequality in India is higher than what we believe by looking at these estimates.

Importantly, inequality of consumption is about inequality of results and not inequality of opportunities, which may be more important but are much harder to measure. Such inequalities are associated with gender or caste, access to key social services, particularly healthcare and schooling and access to credit markets; and these tend to undermine productivity, retard growth and consequently impede the task of poverty reduction. To achieve a higher rate of poverty reduction and make the growth process more inclusive, India will need to address these inequalities in opportunities that impede poor people from participating in the growth process. This will require increased spending on education and health, and creation of quality jobs and social safety nets for the poor and vulnerable. Conditional cash transfers (CCTs), which reinforce focus on schooling and health, if designed and targeted appropriately, can also go a long way in addressing such inequalities of opportunity. Allowing children to move faster and higher up the education ladder than previous generations will enable them to enjoy better prospects in the workforce than their parents. Research at the International Poverty Centre has found that CCT programmes such as Bolsa Familia and Oportunidades were responsible for about 21% of the fall in the Brazilian and Mexican Gini coefficient, each of which fell by approximately 2.7 points between mid-1990s and 2000s.

Over the last few decades, India has lifted people out of poverty at an unprecedented rate, but the pace of poverty reduction is being seriously challenged by rising inequality, which hurts GEP.

This makes a strong case for prioritising distribution and making income distribution more equal before embarking on a high growth path. Moreover, increasing inequality could undermine the basis of growth itself by reducing social cohesion and undermining the quality of governance by increasing pressure for inefficient populist policies. That myopic political responses to growing inequality to assuage voters can have disastrous consequences for the economy is well explained in Raghuram Rajans book, Fault Lines: How Hidden Fractures Still Threaten the World Economy. It was to address the rising income inequality in the US that credit, in particular housing credit, was pushed on low income households fuelling the crisis. It is therefore imperative that in the quest for higher economic growth we do not ignore the perils of rising inequality, one of the most pressing problems we are likely to face in the coming decade.

The author is an economist with a keen interest in the field of poverty and inequality in developing countries