Fiscal Prudence, Jobs, Safety Nets: The Building Blocks To Tackle Inequality

Outgoing American President Barack Obama has dwelt at length on the problem of inequality in an article he has penned in The Economist. Titled ‘The Way Ahead’, the article talks about four issues his successor will have to focus on. In this, he talks about inequality increasing across the world, and more so in the United States, how 1 per cent of humanity controls as much wealth as the remaining 99 per cent and how CEOs (chief executive officers) are now taking home a salary that is 250 times that of the average worker (against 20-30 times at one time).

The article will be waved around by the anti-LPG (liberalisation, privatisation, globalisation) brigade as a vindication of their stand and to push for a slowing down of these three trends (though globalisation is slowing down any way in the face of increasing protectionism).

Even those who sensibly argue that some inequality is needed in society – if everyone is perfectly equal, why should anyone strive harder than the next person – will readily admit that extreme inequalities (though that may be hard to define) may not be desirable. But is inequality actually growing?

Some facts from a recently released World Bank report, Taking on Inequality. This plots data since the 1990s to show that there has been a reduction in income inequality worldwide. This, it says, is the first such reduction since the Industrial Revolution; inequality rose steadily between 1820 and the 1990s.

The global Gini index (a measure of inequality), the report shows, kept rising since 1820, but started to drop in the late 1980s and early 1990s – the period of increasing globalisation. The sharpest drop came between 2008 and 2013, when the Gini index fell from 66.8 to 62.5. This was largely because rising incomes in India and China brought about a convergence in average incomes across countries.

However, this reduction in inter-country inequality was not mirrored within countries. The report notes an increase in inequality within countries, especially in developing countries. It looks at the Gini index of four countries – Argentina, China, India and Indonesia – and points out that while inequality in India has been more muted than the other countries, it has been moving up since the second half of the 2000s.

The report attempts to measure shared prosperity, defining it as the growth in the average income or consumption of the bottom 40 per cent of the population. If the incomes of the bottom 40 per cent grow faster, it is an indication that prosperity is being shared with them faster too.

It also works out a shared prosperity premium – the difference between the growth of the bottom 40 per cent and the growth in income at the mean in each country. This, it says, gives a sense of the share of prosperity going to groups other than the bottom 40 per cent. A positive premium shows that the prosperity of the bottom 40 per cent was higher than that of the mean (and are, therefore, better off); a negative premium will indicate just the opposite.

The report finds that between 2008 and 2013, the bottom 40 per cent in 60 out of 83 countries that were monitored (representing 67 per cent of the world’s population) showed positive income growth. Of these 60 countries, 49 reported a positive shared prosperity premium. However, the incomes of the bottom 40 per cent declined during this period in 23 countries.

The report flags the fact that the shared prosperity premium, though in the positive zone overall, was negligible. The average annualised growth in the income or consumption of the bottom 40 per cent, it notes, was 2 per cent worldwide between 2008 and 2013; but the the average shared prosperity premium was only 0.5 percentage points. It also points out that India is one of the countries in which the share of the top 1 per cent in total income has been increasing.

So how is the gap to be narrowed? The report looks at five countries which have seen sharp reductions in inequality – Brazil, Cambodia, Mali, Peru and Tanzania – and India can, perhaps, take some tips from each of them. Each of these countries has seen a significant reduction in the Gini index between 2004 and 2014.

What stands out is that most of the countries, especially Brazil and Peru, ensured macro-economic stability and followed prudent fiscal policies as well as structural reforms.

The curbing of fiscal profligacy allowed these countries to invest more in social infrastructure, especially health and education, as well as other basic services. Brazil, the report points out, had achieved almost universal access to electricity by 2014 because of a huge push to rural electrification. The share of households in the bottom 40 per cent with a toilet connected to a sewage network increased from 33 per cent to 43 per cent between 2004 and 2013.

Redistributive policies too had a role to play, but the form such redistribution took was not always price-distorting subsidies that still find favour in India. The report notes that Brazil’s conditional cash transfer programme, Bolsa Familia, saw a three-fold jump in coverage between 2004 and 2014 and explains 10-15 per cent of the reduction in income inequality. But how social spending is done is important. In Peru, the report says, public transfers are responsible for less than 10 per cent of poverty reduction in the last decade, though it too has a conditional cash transfer programme, Juntos.

A burst of job opportunities outside agriculture also played a role. In Cambodia, regular wage employment opened up in garment and apparel exports, tourism, real estate and construction. Tanzania saw a surge in retail trade and manufacturing, especially in food processing. These are sectors which do not require highly skilled workers. This is something extremely relevant to India and enabling these sectors to grow is what the government should be focusing on.

In Peru, too, the report found that the opening of the labour market was the main contributor to the reduction in poverty and inequality. And even though restrictive labour laws have ensured that Peru has one of the highest levels of informality in Latin America, the share of employed in the formal sector doubled between 2004 and 2014, and there was a narrowing of the wage gap between formal and informal workers.

There is no getting away from the fact that growing inequality will lead to social tensions. India is already seeing some of those tensions as the aspirational class finds itself increasingly dissatisfied. The only way to address this is through this simple message from the World Bank report: