Column : How India can reduce inequality

Written by Michael Walton | Michael Walton | Updated: Jul 24 2010, 02:36am hrs
Brazil didnt win the World Cup, but it has achieved something that it has found much more elusive: it has finally significantly reduced inequality. The same has been happening in many other Latin American countries. So, can Indian policymakers relax If inequality eventually takes care of itself even in Latin America, the archetypal unequal region, surely India need not be concerned. In fact, the opposite is true. The Latin American experience is a cautionary tale for India, illustrating both the centrality and difficulty of tackling inequality.

Is this comparison relevant Arent Brazil, Chile, Colombia and Mexico in a different league from India in terms of inequality Observers often cite the relatively modest levels of inequality in India found in the National Sample Survey. Indias Gini coefficient (a synthetic measure of differences) was some 0.35 in 2004-05. Brazils Gini coefficient hovered around 0.59 until 2001, before declining to 0.55 in 2007.

But this is misleading. The NSS is for the consumption of households, Brazils is for their income, and consumption inequality is always lower (since the rich save more). The India Human Development Survey for 2004-05 finds a Gini similar to the NSS, but an income Gini of 0.52, well into Latin American territory. Moreover, what really matters are inequalities of opportunity, and these are profound in India, owing to large differences in educational attainment, access to assets and continuing effects of social identity.

So the Latin American experience is relevant. A recent book from the UNDP helps us see why. The inequality decline matters: it looks like a turning point, even though there is a long way to go. And it has already made a large difference to poverty reduction. The Brazil study estimates that two-thirds of a substantial poverty decline between 2001 and 2007 was due to falling inequality. Growth would have had to be four percentage points higher if inequality had not changed. That kind of contribution to reducing poverty would be of great significance in India.

What was going on The two largest influences in Brazil, and elsewhere, were direct transfers and reductions in labour earnings differentials. Government transfers to households accounted for about half the Brazilian inequality decline, mostly due to old-age pensions and a cash transfer to the poor (Bolsa Famlia, which is conditional on children going to school, health check ups and an assets-based means testlike Indias Below Poverty Line measure). The Bolsa Famlia was substantially expanded under the Left-leaning (but largely pro-market) administration of President Lula da Silva.

The other half of the decline mainly came from reduced wage differentials, especially linked to skills, and also to inter-regional and inter-industry wage differences. The fall in skill differentials represents a reversal of earlier increases. When Latin America opened up in the 1980s and 1990s, most countries experienced rises in relative wages, especially of college-educated individuals, as the economic restructuring increased the demand for skills. Only in the 2000s are the benefits of early expansions in education being reaped, a product in many countries of the return to democracy in the 1980s.

So this looks like a happy story of the efficacy of social policy: well-designed social transfers and the massification of education make a big difference. Politics laid the basis for this. Isnt this good news for India

Unfortunately, its not so easy. Several features of Indias current condition could jeopardise or delay such a scenario. India is early in its economic transition. Despite the global profile of top companies, overall economic development is decades behind middle-income countries such as Brazil and Mexico. Yet the rising demand for skills is already well under way and could go faster than in Latin America, as global technological change has continued apace. Crucially, this collides with two other factors. The educational level and distribution is worse than even these Latin American comparators. And at this stage educational inequality generally rises before falling. Then there is a big political economy issue: India has a stack of ill-designed transfers, entrenched in the political process. Unless there is major reform of subsidy programmes, PDS, etc, it wont be able to afford well-designed pension schemes or conditional cash transfers. Also, delivery on quality education or effective transfers depends fundamentally on the institutional basis for delivery and this is weaker than most Latin American countries.

So we come back to some core themes. Inequality matters. The recent Latin American inequality decline is good news but only highlights Indias challenge. Inequalities get entrenched in the system, can further corrupt state performance and will eventually undercut the growth process. Tackling Indias inequalities cant be relegated to the future.

The author is at the Harvard Kennedy School and the Centre for Policy Research