Pro-poor policies can lessen economic inequality

Jaspal Singh
Principal Secy, Planning, Punjab

BRITISH statistician and economist Arthur Bowley propounded that the share of labour in national income remains constant over time. This came to be known as Bowley’s Law. It held its own till 1970, after which it started crumbling the world over as inequalities started rearing their ugly head. India has been no exception. However, the issue has got considerably focused attention in recent years, partly due to the debate generated by the World Economic Forum — an annual affair of the world’s rich who recently met at Davos (Switzerland) — and partly due to the work done by Lucas Chancel and Thomas Piketty, besides organisations such as Oxfam.

The working class is hit hard as its share in the national income goes down. It hurts the rich, too. The share of national income, which is denied to the working class due to inequalities, fails to contribute to the aggregate demand, thus inhibiting economic growth. The share of national income, cornered by the capitalists, contributes to the aggregate demand but only partially because a major part of that income is saved, a part of which gets invested in assets such as gold and real estate. This investment in unproductive assets also contributes to black economy. Inequalities hurt market efficiency as well. Businesses are driven by the profit motive. High capital share in national income satiates this profit motive and thereby curtails the need for both investment and innovation required to maintain bottom lines. High capital share, thus, inhibits growth. Since in a scenario of inequality, the lion’s share in growth is pocketed by the rich capitalists, their interests are also hurt as growth gets curbed.

Thomas Piketty, in Capital in the Twenty-First Century, theorises that if the rate of return on capital is more than the rate of interest, inequalities accentuate. The underlying principle seems to be that in the case in hand, the capital is earning a much higher rate of return at the cost of the workers, thus contributing to inequalities. But there are other factors too. The first and primary among them is the low level of wage rates as compared to executive salaries and the shareholders’ dividend. The problem is severe in the countries with large populations and low productive capacities, leaving the labour to the mercy of the market forces. As Keynes found, markets equilibrate at less than full employment. The market economies present a scenario where labour supply exceeds demand, which exposes labour to exploitation.

The key question is how the wages should grow over time to maintain a fair share of the labour in the national income. The first factor to be considered here is the inflation prevailing in all growing economies. As the physical goods and services produced remain the same, inflation becomes a zero-sum game. The incomes of the producer-suppliers increase with inflation, while the purchasing power of the consumers goes down. A rise in wage levels equal to the rate of inflation will, therefore, ensure a steady but stagnant standard of living for the workers. However, as the economy grows, it will be unjustified if the workers’ standard of living does not improve. It will, therefore, be tempting to say that wages should increase at the real rate of growth increased by rate of inflation to maintain a constant share of labour in the national income. However, as the population also grows, this wage level will lead to distortion and the share of labour in the national income will grow disproportionately high. The rate of growth of wages, therefore, should be the real growth rate of economy plus the rate of inflation minus the rate of population growth. The regulatory framework must ensure that this growth in wages is actually realised, failing which inequalities are bound to widen. An important policy tool here could be the prescription of appropriate minimum wages and more importantly an effective mechanism for its implementation.

Tax policies are the second important factor to be considered to deal with disparities and inequalities. Progressive tax policies, which require the rich to pay at higher rates than the poor, ensure that distortions due to the low wage rate are corrected to some extent. However, progressive tax regimes are as good as their implementation. Thus, tax evasion and tax dodging by the rich can easily counterbalance the effort. Indian economy with progressive tax policies but high tax evasion and tax avoidance is a case in point. Inequalities are further manifested in wealth disparities. Wealth tax or inheritance tax could be another policy tool to deal with economic disparity.

The third major factor is the public spending policies of the government. Public spending on education, healthcare, social welfare and other services availed by the poor can go a long way in addressing economic inequality. It ensures that a higher share of the national income is made available to the poor. Greater emphasis on the social sector also equips the poorer sections of society to contribute better to national growth and increase their own earning capacities. The indirect subsidies, such as the fertiliser subsidy, routed through the suppliers, often end up lining the pockets of the rich. The use of modern technology (direct transfer of money to beneficiary accounts) presents a good policy option to the public authorities to directly address inequalities.