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
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.
Well articulated,concise and quite relevant to the times.
ReplyDeleteWell articulated,concise and quite relevant to the times.
ReplyDeleteInteresting insights, would also love to hear the implication of the above on financial markets. If Modi continues to do the same, with a hope that Income inequality decreases , what would it mean for Indian GDP growth and impact on financial markets.
ReplyDeleteYes, very nicely written. But what are the alternatives to the Trump/Modi thoughts?
ReplyDeleteGurudas