Indias growth-inequality predicament

Written by rajesh shukla | Updated: Nov 24 2013, 00:31am hrs
Across the world, concerns are being voiced about rising inequality and how severely it can damage the social fabric of a nation.

In the Indian context, concerns have been eloquently articulated by some of the very well-noted economists who fear that the governments fixation on growth prevents it from effectively addressing the problem of rising inequality and its structure. While no one refutes the claim that some benefits accruing from the economic reform growth have trickled down, a consequence of which is the millions who have been uplifted above the poverty line, the bone of contention is that a certain privileged section of society has received a disproportionate share of the benefits accruing from the growth process which has translated to rising vertical as well as horizontal inequalities.

Economic growth can translate to either an increase or decrease in inequality; if inequality does rise, it implies that a certain section of society is receiving a disproportionate share of total benefits accruing from growth. On the other hand, if inequality falls, it implies that the benefits are percolating to the economically-deprived sections of society. As with poverty, a number of studies on inequality, based on NSS consumption expenditure data, have been carried out in the post-reform period with mixed results. It is interesting to note that the so-called poorest state in the country, Orissa, has shown the steepest decline in poverty ratio24.6 percentage points between 2004-05 and 2011-12 (table 1).

Other states where the decline in poverty ratio is significant include Andhra Pradesh, Bihar, Maharashtra and Uttarakhand. Interestingly, in all these states, rural poverty declined at a much faster pace than urban poverty. Relatively high economic growth in some of the BIMARU states (Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh) and Orissa has led to a significant dent on overall poverty.

This is much pronounced in rural areas of all major states other than Kerala, where urban areas witnessed a higher reduction in poverty estimates. It is quite plausible that benefits of long-term high growth, especially in the low-income states where the benefits of growth percolate to the economically-backward rural sections, can be easily envisioned.

This reveals the dichotomy between monthly per capita consumption expenditure (MPCE), growth and the corresponding poverty reduction, which leads us to the issue of the distribution of households near the poverty line. In other words, if households are heavily distributed near the poverty line, even a small increase in MPCE can lead to a disproportionately large reduction in poverty. For example, in the states of Orissa, Bihar and Maharashtra, MPCE in rural areas grew at 11.5%, 11.8% and 13.5% per annum, respectively, and the corresponding reduction in poverty in the states stood at 25.1%, 21.6% and 23.7%, respectively. The difference in the poverty reduction figures is because, in Orissa, households are concentrated around the poverty line, unlike in Maharashtra. The other limitations being that a fall in MPCE, which lowers households into abject poverty, has no effect on the index.

In an attempt to examine the impact of growth on poverty alone, the reduction in poverty is decomposed into two components: (1) a growth component and (2) a distribution component. While the growth component reflects the increase in per capita expenditure, the distribution component captures any change that may have taken place in the distribution of per capita expenditure.

While the Gini coefficient is the most commonly used inequality measure, this article focuses on the General Entropy (GE) class of inequality measures. The parameter in GE(a) represents the weight given to distances between incomes at different parts of the income distribution. For lower values of (a), GE is more sensitive to changes in the lower tail of the distribution, while for higher values of (a), GE is more sensitive to changes that affect the upper tail (Litchfield, 1999). A value of 0 gives more weight to distances between incomes in the lower tail.

For the purpose of current analysis, the author has estimated GE(0). GE(a) can be easily decomposed into between group inequality and within group inequality (Litchfield, 1999).

The first component indicates the extent of overall inequality that would remain if incomes were equalised within each population group, that is, if each member of a particular group was given the groups average per capita income. The second component captures the amount of inequality that would remain if differences between groups in terms of their average incomes were eliminated and only within group differences remained.

Tables 2(a) and 2(b) present the inequality decomposition exercise carried out for the period under consideration. Inequality has been calculated by taking rural and urban areas as the population subgroups. Total inequality, based on consumption expenditure, as measured by GE(0), has risen from 0.195 in 2004-05 to 0.210 in 2011-12. Results reveal that between and within groups inequality components have risen (expressed as a percentage of total inequality) and this is true for both rural and urban areas, implying that inequality between rural and urban areas has actually widened.

However, the all-India trajectory masks the widely varying trends in consumption inequality across the states. Inequality has, in fact, sharply increased in the BIMARU states, Uttarakhand, Kerala, West Bengal and Karnataka. The rise in inequality in the low-income states can be attributed to the presumption that the benefits of economic-growth are more absorbed among the upper tail of income distribution particularly in the urbanite population. In the middle and high income states, higher inequality could be the result of a particular section of society having more access to resources, or the concentration of knowledge-based industries in a few cities, by providing higher returns to education, is causing inequality to rise.

It needs to be pointed out that inequality in India is estimated on the basis of consumption expenditure and not income. This implies that if two individuals with identical consumption expenditures but different levels of income are added, inequality would not increase. The point is, income not being spent does not render it irrelevant. It is being saved/invested to finance consumption at a later date. We have evidence to support the claim that income inequality had, in fact, increased from 1994-95 to 2004-05. It is, therefore, quite possible for inequality estimates, based on different indicators such as consumption expenditure, wages, income, and so on, to put forth different results and, thus, lead to different conclusions.

Our analysis shows that while the period from 2004-05 to 2011-12 saw a considerable reduction in poverty, it has also witnessed a widening of rural-urban disparities. At the state level, consumption-based inequality has, in fact, risen in quite a few states. While it can be argued that development does not start in every part of an economy at the same time and that it should be viewed as part of the growth process, the fact remains that it continues to widen even after two decades of reforms. What should concern policymakers is not that the rich have gotten richer but the inability of the lowest sections of society to actively participate in the India growth story.

When forecasts are made about future growth rates of India and China, economists have tended to give the upper hand to India. The demographic dividend is one of the main factors often cited for the favourable outcome. However, as economists have cautioned repeatedly, given the sorry state of affairs of the education system, one should not take for granted the fruits of the demographic divided. Serious doubts have been raised about its ability to provide the necessary qualifications to the labour category to ensure a smooth transition from agriculture to manufacturing and services.

Thus, the debate on growth and inequality is not about choosing one over the other. Growth is important as it not only provides employment opportunities, but it also provides, through taxes, revenues to the government to finance expenditure on social-welfare schemes. Instead, the focus should be on removing the obstacles to social mobility. As The Economist aptly puts it, the issue of inequality is not of pulling down the rich. It is of pushing the bottom and the middle up. It is one of removing distortions and imperfections in the system that cause inequality and focus more on increasing social mobility.

The author is professor, Institute for Human Development