Bridging the Income Gap: A Delicate Balancing Act

The world currently seems to be experiencing a “Piketty moment”. Thomas Piketty’s magnum opus, the controversial, surprise bestseller, “Capital in the Twenty-First Century” perhaps very adequately captures the events which have unfolded in 2016. In his book, Piketty derives a simple theory of capital and inequality. According to him, wealth grows faster than economic output if r>g (where “r” is the rate of return to wealth and “g” is the economic growth rate). Other things being equal, faster economic growth will diminish the importance of wealth in a society, whereas slower growth will significantly increase it. However, there are no natural forces pushing against the steady concentration of wealth. Only a burst of rapid growth (from technological progress or rising population) or government intervention can be counted on to keep economies from returning to the “partrimonial capitalism” that worried Karl Max. Piketty closes the book by recommending that governments step in now, by adopting a global tax to wealth, to prevent soaring inequality which could result in economic or political instability down the road. 

While Piketty’s thesis and recommendations are debatable, there is no denying that income inequality is leading to political upheaval across the world. The unprecedented rise of Donald Trump as well as the British vote to leave the Eurozone bears testimony to the fact. Post the Global Financial Crisis, anemic global growth combined with the extreme expansionary stance of central banks has had the effect of increasing wealth disparity by benefiting foremost the wealthy. This is well reflected in the sharp divergence in performance of financial assets (Wall Street) vs. wage growth (Main Street) in recent years. It comes as a no surprise then that electorates all over the world are now demanding a new “War on Inequality” by policy makers, requiring less taxpayer’s money being spent on bonds and more money on people via fiscal stimulus to boost wage growth. If 2016 is anything to go by, then 2017 could prove to be even more interesting given the election heavy political calendar globally.

          Chart 1: US wealth inequality - Top 0.1% hold the same amount of wealth as the bottom 90%

                                       Source: Deutsche Bank Research

No discussion on income inequality can be complete without a mention of India. This is because as per a recently released Credit Suisse report, India is the second-most unequal country in the world with the top 1% owning 58.4% of the economy’s wealth. The gap is not only large but rising. A long dated history of corruption and crony capitalism has been one of the biggest factors contributing to the rising gap between the rich and poor. This ever increasing gap has finally started to impact the political landscape of the economy through the emergence of anti-establishment politics. This probably also explains the historic rise of Modi – a "chaiwala" who promised greater transparency, breaking of oligarchic structures and “ache din for all”.

 Chart 2: Inequality is rising rapidly in India

                                        Source: International Monetary Fund (IMF)

With almost three years in power, Modi’s policies can be distinctly divided into two parts. The first part focused on the upliftment of the poor through productivity enhancing techniques – Jan Dhan Accounts, Direct Benefit Transfer, Skill India, Mudra Bank, etc. These schemes had the dual effect of curbing leakages in the system (thereby preventing the corrupt from getting richer) as well as providing adequate resources to the poor for a better life. It is important to note that none of these measures had any element of populism via direct dole out to the poor. Instead, it focused on a more sustainable upliftment of the underprivileged without hurting the “private sector”.

The second part of Modi’s tenure on the other hand seems to be in stark contrast to his first. It now seems that Prime Minister is determined to position himself as the “Indian Robinhood” – i.e. taking away from the rich and giving to the poor. A clear example of this is the recent demonetisation exercise. What the exercise aims to do is generate a “negative wealth effect” where the richer section of the society is left feeling poorer and then use the bounty to redistribute to the less privileged. In fact, last year’s Economic Survey had a special section called “Piketty in India: Growing Concentration of Incomes at the Top”. One of the suggestions it gave to reduce the income disparity included: reducing bounties for the rich and taxing the well-off regardless of the source of income. In a recent speech, Mr. Modi proclaimed “those who profit from financial markets (rich) must make a fair contribution to nation-building through taxes. For various reasons, the contribution of tax from those who make money on the markets has been low. I call upon you to think about the contribution of market participants to the exchequer”.

 

All the above indicate a very clear change in stance – helping the poor even if it inadvertently hurts the “private sector”.

 

There is no denying that a more equitable distribution of wealth is desirable and the need of the hour. However, the method to achieve this seems to be a complex issue. Neither Trump’s rhetoric against globalization/immigration appears to be the right solution nor Modi’s growth impacting demonetisation program. The key thing to remember is that higher inequality goes along with lower economic growth, especially in Emerging Economies. Therefore, the right matrix perhaps is to have a more conducive and compliant growth environment rather than one where the private sector feels threatened. The upcoming Central government budget is most likely to have a social upliftment agenda. However, to increase the size of the overall cake, the government has to acknowledge and act in favour of investments and job enhancing policies. Thus, infrastructure spending and tax rationalization has to meaningfully surprise positively to achieve sustainable growth driven income equality. Good intent alone is not enough, balanced policies are needed.