Recently, The Economist magazine featured a prominent article on India’s missing middle class. One point made in the piece was that income distribution in India has become more unequal, and the gains from economic growth have gone disproportionately to the richest 10% of the population. In The Indian Express article of January 20, Surjit Bhalla robustly challenged the numbers used in The Economist article, especially those generated by Thomas Piketty and co-authors. But the original piece acknowledges that Piketty’s methodology has been questioned, and argues that other data sources offer similar conclusions. Even if we are not confident of the precise numbers, I think it is fair to say that India’s distribution of wealth and income is unequal, and has gotten more so over recent years. Indeed, India is one of the many countries exhibiting this trend, as globalisation and technological change favour those who start out with skills, capital and networks.
But the real message of The Economist piece deserves further consideration. The reason income distribution is a concern is that an unequal distribution distorts consumption patterns in ways that inhibit economic growth. Theoretical models of growth can make this idea precise, as in separate research by Abhijit Banerjee and Andrew Newman on one hand, and Abhirup Sarkar on another—these being just two examples. Consumption patterns affect innovation and investment, which are the drivers of growth. Casual empiricism from history seems to be consistent with this understanding, whether it is the negative example of the Mughal Empire, where inequality went with relative stagnation, or the positive one of the East Asian miracle, where several countries grew rapidly starting from relatively egalitarian initial conditions.
I bring up theory and history because they provide benchmarks for the story in The Economist, which argues that broad measures and high counts of the Indian middle class are misleading, because the group defined in that manner does not have the purchasing power to support multinationals such as Amazon and McDonald’s, or even growth in markets such as air travel, smartphones and automobiles. The examples of products and firms used here illustrate why there may be room for optimism. A focus on Netflix and Nike and other multinationals of that nature (where Indian purchasing power is insufficient) misses the markets served by domestic firms, which often have products and services that are more affordable for India’s true middle class, rather than the desired one of the story.
But this reminds us why India’s growth story is not more robust. There are not enough Indian firms that are serving India’s middle class, and doing so at a scale that permits them to enjoy cost economies that keep prices low. India’s problem of purchasing power is related to the lack of domestic firm entry and growth. In some cases, low-cost products that meet the needs of the aspiring middle (and this means a step up from the sachets of shampoo also mentioned in the article, which were aimed at the lower-end of the income distribution) can be imported, but many types of products might require knowledge of local tastes, or not have the right economics for profitable import.
The other side of the coin is that making middle-class goods in India would generate the jobs that the country needs. And these jobs would generate the purchasing power that is not quite there, but needs to be. In a recent piece in The Economic Times, Arvind Panagariya compares giant Reliance Industries with Shahi Exports (India’s largest apparel exporter) and calculates that Shahi creates 250 times as many jobs for the same investment as the larger firm does. Panagariya’s argument is focused on exports, but he applies it to a wide range of light manufactures. Many of these products are going to be middle-class purchases, which can become cheaper with economies of scale from serving global markets, or higher quality from serving international customers.
Of course, this production can be done by multinational firms investing in India, as well as domestic firms. But they have to produce for the market that is there, not one which is a decade of growth in the future. So the lament about the lack of a middle class for multinationals to profit from should really be about India’s lack of inclusive growth, which, in turn, is about why firms in India do not grow and compete globally, and why hiring workers is not more appealing to firms that do want to grow. Panagariya emphasises rigid labour laws, and lack of physical infrastructure. The Economist emphasises lack of adequate education and health care. Both are right.
The question that rears its head from this story, then, is why have 25 years of economic reform and growth not made more of a dent in these constraints to India’s development, and the flourishing of a more robust middle class? Is the problem one of political economy, or of poor governance quality, or of outdated ideas? The Economist writes about the potential disappointment of multinationals, but the important story is the ongoing disappointment of the bulk of India’s people.
The author is professor of Economics, University of California, Santa Cruz