Income Distribution and Economic Growth: A Macroeconomic Perspective with
Reference to India
Arun Kumar
CESP/SSS, JNU.
I. THE EMERGING
GLOBAL CRISIS in 2011
The rich in many European
nations have asked their governments to tax them more. This follows the call
made by Warren Buffet in the United
States that the rich should pay more taxes.
The motive is self-interest: to save their economies from sliding further and
going into a double-dip recession, and preventing the kind of youth violence
that has been witnessed in many countries in Europe.
The recession looming on the horizon (if the world is not already in it) will
be more difficult to deal with than in the earlier rounds since this time the
cause is political rather than financial, as the case was with the global
recession that started in late 2007.
In 2007-08, the experts and
the analysts were ‘behind the curve' and in a state of denial about the start
of the recession. The International Monetary Fund did not acknowledge the recession
till late 2008, almost a year after it had started. Ben Bernanke, the head of
the U.S. Federal Reserve, only admitted problems in February 2008 when the
first stimulus tranche of $160 billion was announced. The U.S. Treasury
Secretary did not admit of basic problems in the financial sector even in July
2008 when Freddie Mac and Fannie Mae faced imminent collapse.
Globally, governments boosted
demand following the Keynesian device of creating deficits. The U.S. budget
deficit went from 3 per cent of GDP to 12 per cent. The same thing happened in India. China provided
a $600-billion infrastructure boost. Japan
and much of Europe went in for budget deficits
to boost demand in their economies. Nonetheless, unemployment rose sharply
everywhere. In the U.S.,
it reached the level of 9.6 per cent. In India, exports which were growing
at 35 per cent started plummeting at 35 per cent, leading to large-scale
unemployment in labour-intensive sectors such as textiles, gem and jewellery
and leather goods. Many industries and services such as transport, finance and
real estate went into a tailspin.
The reason for the anemic
recovery was that the stimulus was nowhere as big as was needed to boost
employment and revive economies in a strong manner. So, when the big economies
started climbing out of the recession in early-2010, employment hardly rose in
the major economies.
Politics entered the picture
globally soon thereafter. The conservatives started pushing the neo-classical
paradigm of tax cuts for the rich and balancing the budget. The anemic recovery
was used as an excuse to argue that the Keynesian prescription to boost the
economy does not work. The implication of the conservatives' programme of
cutting taxes on the rich leads to a decline in tax revenue so that the deficit
tends to grow. But since the budget has to be balanced, expenditures have to be
curtailed — the opposite of what the economy needs. In Britain, the new Conservative
government cut back the budget and reduced public sector employment by half a
million.
In the U.S., after the
Democrats' big losses in the 2010 elections, President Barack Obama could not
push his expenditure programme and had to reach a compromise with the
Republicans. At the beginning of August 2011, the U.S. government almost came to a
grinding halt due to the logjam between the two political forces. This left the
markets in panic.
The world economy faces a
deep crisis for political reasons. This is not palatable to the conservatives,
who once again have a grip on power in the major economies of the world. India is no
exception to this conservative mood with the government talking about balancing
the budget in stages.
II. DEFICIENCY
OF DEMAND AND CYCLES IN CAPITALIST ECONOMIES
Kalecki (1971) showed why
demand in a capitalist economy would be short in the normal course. He argued
that capitalists are atomistic decision makers so that their decisions to
invest would not automatically equal the full employment level of investment. He
critiques Luxemburg’s argument that exports can help overcome demand deficiency
by providing an additional market to the capitalists. Further, he negates Baranovski’s
argument that investment in machines for the sake of machines can generate
demand and help overcome demand deficiency. Kalecki argued that the external
market is not exports but export surplus and further that investment in
machines cannot increase endlessly.
He showed that growth impulses for a capitalist economy are
Investment, export surplus and government deficit. Out of these, the first is limited
globally by the atomistic decision making of investors and lack of coordination
in the world to achieve full employment level of investment. Regarding the
export surplus, one country’s surplus will be another’s deficit so the world as
a whole cannot have a surplus. Thus, globally there cannot be a surplus and no
stimulus from trade is feasible. However, every government can have a deficit
in the budget and each economy can work to increase its demand. In open
economies, demand will tend to leak to others but everyone can gain together.
This above prescription from Kalecki is not to the liking of
the capitalists since they do not like full employment (Kalecki, 1971). He points out that because of this, economies now go
through political business cycles and not the earlier kind of business cycles. The
capitalists do not like govt. intervention because it is seen to have anti-capital
implications. Hence the neo-classical orthodoxy suggests that the state should
withdraw from the economy. This underlies the Washington Consensus since the
eighties and has been in operation India since the launch of the New
Economic Policies (NEP) in 1991.
II.1 Reaganism
and Thacherism in the World since Late Seventies, Washington Consensus and Deepening
Marketization
The world has been globalizing for a long time but its form
keeps changing from time to time. It has been following a one-way pattern since
the beginning of colonization in 1750 (Kumar, 2001).
Most influences have been going in one direction – from the West to the current
developing world. This one-way globalization has also gone through different
phases. The latest one beginning with Mrs. Thacher’s rule in UK from the late seventies and Mr.
Reagan’s Presidentship from 1980. They have pushed the world in the direction
of marketization. The global institutions of economic governance, like, the IMF
and the World Bank, have toed this line.
This was also possible because of the global strategic
changes with the weakening of the USSR since the mid seventies and the 180
degree turn in economic policies in China after Mao’s departure. The changes
were also visible in the negotiating stance of the advanced capitalist
countries in the then GATT. They started pushing the developing world from the
early eighties to agree to the new issues – trade in agriculture, trade in
services, TRIPS, TRIMS and so on. They succeeded in the Uruguay Round of
negotiations in 1986 in introducing these issues in GATT negotiations and
managed to change GATT to WTO in 1995 with all the new issues as a part and
parcel of the new organization.
In other significant change developing countries used to
receive from the developed world `Aid’ at concessional terms. The underlying
idea was to help them to `develop’. From the early nineties, this changed to
capital flows at market related interest rates. The developing countries had to
attract capital by offering onerous terms and concessions. Focus now shifted to
FDI and FII flows and domination of MNCs.
The idea of marketization is not just economic but also
social. It has resulted in the penetration of the market philosophy into social
and political institutions also. People have been turned into `homo-economicus’
– solely determined by economic considerations of gains and losses. Their
social and political aspects of existence have become immaterial. They are
taken to be rational being maximizing their gains. Whether it is marriage or
raising children it is all taken to be motivated by individual gains.
Under this philosophy, economic growth is the growth of
human activity whether associated with human welfare or not. It has led nations
to adopt the philosophy of `growth at any cost’. The entire burden of such
blind growth mania has fallen on the environment and the marginalized sections
of society who have little say in the market. With this philosophy, distribution
hardly matters and inequalities have dramatically increased in the world - in
each country and across groups of countries, like, in the US, India and China.
Investment is being recklessly carried on for the sake of investment without
taking into account the long run. The limitations of this strategy for long
term growth, due to its consequences for social welfare and growing social and
political instabilities appears to be no one’s concern today.
II.2. Distribution,
Inequality and Growth
As argued in Section II.1 above, since the seventies, distribution
of incomes is not a consideration and there is rising inequality. This impacts
consumption since the rich consume a much smaller proportion of their incomes
than the poor do. Consequently, the consumption propensity declines. This
results in a tendency for deficiency of demand within the economy. The economy
would then slow down unless some external demand is generated like in exports
or through investments as discussed in Section II above.
This has been visible in the case of say Japan and China.
Their savings rate has risen dramatically and they have had to depend on export
markets and rapid increase in investments fore maintaining growth. But, the
large export surpluses of both these countries have led to large national and
international imbalances and instabilities. Hence this kind of strategy has
limitations and cannot be a long term strategy of growth.
II.3. Free
Trade, growing disparities and impact on Demand in world economy
The global economy has come under the WTO regime since
January 1, 1995. As a result, competition amongst developing countries has
increased for selling low and intermediate technology goods in the
international markets. The advanced countries maintain there monopoly over
advanced technology goods and control its prices. But, the developing countries
competing with each other have lowered the prices of the goods they sell. Thus,
terms of trade have shifted against the developing countries and in favour of
the advanced countries.
To maintain low prices, the developing countries have held
back wages of workers. The position of workers has weakened globally as
international competition has enabled capital to gain an upper hand. But the
weakening has been even greater in the developing world. Labour has lost many
of its rights it had gained through struggles since the Second World War. For
instance, in India,
courts have reversed some of the earlier judgments which had granted workers
rights. Currently, in the call centers and BPO sector, even trade unions are
not allowed.
These two global
trends are aggravating income disparities across countries and within each
country aggravating disparities between capital and workers. As argued above,
this is resulting in a tendency for deficiency of demand globally.
II.4. Black
Economy, Global Illegal Flows and Inequality
Another
important factor for the rising inequalities globally is the growth of the
black economy in various countries and especially in the developing economies.
Typically, the black economy is concentrated in the hands of the already rich,
the profit earners who try to increase their incomes by illegal means. They
share a fraction of this with the other elite sections of society, like, the
politicians, the bureaucracy, the police and the judiciary. This is at the
expense of the marginalized sections of the population who are the majority in
the developing countries. Further, as illegality has increased in the developing
world, the size of the black economy has been growing. The effect of the growing
black economy leads to aggravation of inequality within countries and also
across countries.
Globally, black incomes earners are using tax havens to both
take their capital out of their national territories as well as round trip it
back to their countries. The tax havens are also used by the corporate sector
to siphon profits out of the developing countries via transfer pricing or under
and over invoicing of exports and imports.
In India, the black economy has rapidly increased and now
amounts to about 50% of GDP. It is concentrated in the hands of at most 3% of
the population (Kumar, 1999). Thus, as the black
economy has grown the income gap between the top 3% in the income ladder and
the rest has grown rapidly.
The result of the growing black economy is to aggravate demand
problem both nationally and globally (Kumar, 2009).
III. INCREASING
GLOBAL INSTABILITY SINCE THE SEVENTIES
Globally income distribution has deteriorated in the last
forty years. Paradoxically, some countries, like, China and NIC have grown rapidly –
narrowing the gap with the rich countries that have grown relatively slowly in
this period. So, across nations disparities may show reduction but within each
nation, disparities seem to have risen – within the US,
China, India, Europe,
etc. Thus, disparities between the elite and non-elite globally appear to be
growing.
This seems to be creating a global tendency for shortage of
demand. While for individual countries, exports may generate additional demand
(as for China)
for the world as a whole exports cannot counter the demand deficiency since
there cannot be a global trade surplus.
The tendency for global demand deficiency is countered by
rising levels of investments in Asian economies and the growing levels of
consumption in the largest economy – USA.
The USA has shown declining levels of savings since the
mid-eighties. Its consumption levels have been driven by the wealth effect
based on asset price rise. Stock markets and other markets have shown a rise
with the result that the paper wealth has increased and the rich and the middle
classes have been spurred into increasing levels of consumption. Consumption
has also been spurred by rising availability of consumer loans. This has
fuelled demand in the rest of the world. Under Reagan, the USA went in for
massive increase in military expenditure and that also spurred a budget deficit
and global demand.
The result is that savings and investments rates have risen
in Japan, China, NIC and India while they have fallen in the USA. So, there
have been current account surpluses in China,
Japan and NIC while there
has been a deficit in USA
and other countries. In effect, the world has polarized between the savers and
consumers.
III.1. Dollarization,
Demand in the World Economy and Uncertainty
How has this global imbalance been sustained since the
eighties? This was made possible by the dollarization of the world economy.
People all over the world were willing to hold dollars and treasury bonds. So,
the deficit in the US
current account and in the budget could be sustained by the return flow of
capital from the surplus countries. Bulk of the rising reserves of China and Japan were in US treasury bills.
The outflow of dollars from the USA to Russia, Central Asian
Republics, Latin America was possible because it was seen to be stable. Savings
in these countries were held in dollars as a safe currency. Thus, the dollar
became like the reserve currency – a safe currency that the rest of the world
was willing to hold. Thus, the US
could pay for its excess imports by paying with dollars. No other country in
the world could do this.
This circular flow of dollars in the world allowed the
largest economy to sustain a rising level of consumption which led to leakages
of demand to the rest of the world. This led to a boost of demand in the world
and also to rising investments in the export surplus economies further boosting
demand.
As already pointed out, demand globally was also fuelled by
the rising asset prices – of stocks, real estate and other financial instruments.
These paper gains meant that people felt they were richer and spent more.
However, the rise in asset prices is like a bubble.
In brief, two kinds of instabilities were building up in the
world economy – the global savings-investments imbalance amongst nations and
the creation of the asset bubble. Both these imbalances were unsustainable over
the long run. For instance, rising exports of China
and Japan
could only be sustained if their currency remained undervalued in relation to
the dollar. Their rising reserves were not allowed to increase the value of
their currency by appropriate interventions.
The rising amount of dollars held abroad and the rising level
of US treasury holdings by foreign entities was only feasible as long as the
others had faith in the US economy and the currency retained its characteristic
of being a reserve currency. Similarly, the rising asset bubble could only be
sustained by its continued rise and reinvestment of the profits made in such
speculation back into the same assets. This became an increasingly unstable
system over time and finally the bubble burst (for an analysis of this see Kumar, 2009). Of course, as pointed out, there were
other inter-linked reasons as well, like, sub-prime crisis and commodity
speculation but all these were also linked to the global imbalance and growing
disparity across the globe.
III.2. New
Demand Problems since 2008
The crisis of 2008 has changed the above global
macroeconomics. With decline in asset prices, rising unemployment and financial
crisis, share of consumption in the US has declined. With rising
unutilized capacity in industry, investment also declined and finally, crisis
in the financial sector meant that loans were not being given so that small
businesses have found it difficult to operate. The government did increase its
deficit from 3% of GDP to 12% of GDP. The Central Bank provided massive
infusion of liquidity to shore up the financial markets and cut interest rates
to almost zero to stimulate investments but nothing worked. It was as if the
economy had entered a liquidity trap. Thus, the major source of world demand in
the world fell.
The world over, this pattern was repeated – in Euro zone,
Japan, Britain, China and India. Demand declined in spite of the massive
interventions by the Central banks and the increased deficits by governments.
Nations like, China and Japan which had
strong export surpluses faced decline in exports and in surpluses and this
slowed down their economies further.
However, the stimulus no where was as strong as needed
because there is a conservative streak of thinking about deficits and stimulus.
Krugman has been a proponent of a strong
stimulus (Krugman, 2009). In the US, the increase in the government
stimulus has been counter balanced by the rise in savings of the households.
Thus, a stronger government stimulus was needed. However, under the pressure of
the Republicans and the Tea party, the US President has failed to provide
a larger package. The stagnant US
consumption has led to global demand problems.
The Euro zone has had its own crisis of sovereign debt and a
conservative mood based on the poor performance of the economies of Europe.
Thus, austerity measures have been imposed to bring the debt ridden and
supposedly profligate economies into balance. This is further slowing demand
and added to this is the fear of sovereign default. In brief, there is a
vicious cycle of slowing demand and growing global crisis leading to the fears
of double dip recession taking hold.
Major countries facing crisis are likely to go protectionist
since consensus is eluding them. Further, with rising fears of debt default,
the financial sector is facing a another crisis. In this context, the Asian
economies, to protect their interest, may have to depend on generating internal
demand.
IV. THE
INDIAN CONTEXT
The Indian economy started to open itself strongly with the
New Economic Policies (NEP) launched in 1991. While its exports and imports as
a per cent of GDP in 1991 were around 7% (roughly the figures for the USA, Japan
and China)
now these numbe4rs have risen to about 20%.
NEP led to a paradigm change in policies. While earlier the collective
was taken to be responsible for the problems of the individuals (like, poverty,
illiteracy, health and unemployment), now the individual is held responsible
for her/his problems and the state has retreated. The market has taken over
from the state and is playing a leading role in the growth process. This has
meant giving concessions to capital and ignoring the distributional
consequences of policies.
In the nineties, after NEP were launched, the economic
growth rate remained at roughly the same level as in the eighties (Graph 1
shows that the decadal rate of growth was unchanged), there has been a growing sectoral imbalance with
growth dependent on the services sector whose share has risen to more than 60%
of GDP. This imbalance has been based on the relatively slow rate of growth of
agriculture and a rapid rate of growth of the services sector. This is the
source of rising disparities in the economy.
While agriculture still employs more than 50% of the work
force, its GDP share is only 17%. While the Services sector employs 30% of the work
force it contributes more than 60% of the GDP. Thus, those in agriculture are
the majority but marginalized in national income. Since agriculture is
concentrated in rural areas and services in the urban areas, this disparity is
leading to a growing urban-rural divide. Further, since the backward states are
predominantly agricultural, they are lagging behind the advanced states which
have a dominant contribution to the services sector. Finally, since agriculture
employs largely unorganized workers there is a growing divide between the
unorganized and the organized sectors.
The growing disparity is also based on the post 1991
concentration of resources in the hands of the private coporate sector which is
investing in the organized sector and mostly in the advanced states. Thus,
agriculture is receiving hardly 2% of the investment and is lagging behind in
productivity and wages. It is also not generating new jobs. In contrast, the
corporate sector is investing but in capital intensive areas and is therefore
shedding jobs in a kind of jobless growth. Thus, overall few jobs are being
generated and this is resulting in rising under employment.
Growing problems of employment generation and rising
disparities have led to increased political and social instabilities in India.
There have been violent protests against land acquisition for projects and
setting up of SEZs. Other agitations for reservations and affirmative action
have often turned violent since the government is seen as non-responsive and
pro-corporate sector. Growing corruption has added to a poor image of the
government which is seen to be working against the interest of the poor and in
favour of the rich and the corrupt.
To correct its image, government has been forced to go in
for programmes for the support of the poor like, the rural employment
generation, right to food, right to education, mid day meal scheme in schools,
loan waiver for poor farmers and so on. Many of thee schemes coincided with the
need for fiscal stimulus in 2007-09 period. They pumped purchasing power in the
rural areas of India
and prevented demand from rapidly going down. That is why India’s rate of
growth fell much less than that of many other economies of the world. Further,
since this demand is not import intensive, it did not leak out of the economy.
An aspect of the rise in disparities and the black economy
is the dramatic rise in the savings rate from 2000-01 and a simultaneous rise
in the direct tax GDP ratio. Both these are an indication of the rich having a
much larger share of national income (Kumar, 2007).
However, as Graph 1 shows, spurts in growth in the last twenty years have been
short lived.
The lesson of the last twenty years is that internal demand
in India has been very important. This is also likely to be the case for other
developing countries.
IV.1. Has
Growth been for Real?
The rapid growth in some of the newly emerging market
economies has been accompanied by large scale destruction of the environment
and hence needs to be reassessed (Kumar, 2006).
Economic growth should have the connotation of improving social welfare but the
environmental destruction and associated pollution and climate change are
leading to vast negative consequences and especially for the marginalized
sections who are the least able to cope with these changes. With climate change
cropping patterns get disturbed and lead to adverse consequences for
agriculture where a bulk of the poor are concentrated. It is resulting in
unstable prices of food which impact the poor the most.
New chemicals are leading to new diseases and illnesses for
which solutions do not exist and these are affecting the poor the most since
they are the most vulnerable. They are doing most of the hazardous jobs like,
spraying pesticides in the fields or recycling hazardous waste (computer
components, ships, plastic or lead acid waste). The increased expenditure on
health is sending families down the income ladder into poverty in spite of
apparently increased incomes. Thus, such growth is not improving social welfare
Similarly, growth is often based on destruction of assets
created in the past. Factories, roads and airports are coming up where often
productive agricultural fields existed. Thus, new investment needs to be
adjusted for the destruction of past assets and net investments becomes less
than the investment figures shown. Similarly, new output from such investment
needs to be adjusted for the old output that would not be produced. In other
words, more of the past assets that are destroyed the less is the true growth
of the economy. Thus, increased growth needs to be adjusted by providing for
much larger depreciation.
In India, the effect of such adjustment can shave off up to 25%
from the output and growth rate. In this sense, in much of the developing
world, growth in this sense is partly spurious. Current growth is at the
expense of the future growth as the environment deteriorates and health is
adversely affected.
V. CONCLUSION
The global economic problems starting in 2007 are continuing
but for a brief period of respite in 2010. This paper points out that these are
the result of the global imbalance in demand in the last thirty years with a
divide between savers and consumers. This situation could continue for so long
due to the dollarization of the world economy and the wealth effect due to rise
in the asset prices driven by finance capital.
The problem was getting aggravated by the growing
disparities within countries and across groups of countries due to the strategy
of `growth at any cost’ based on marketization and growing consumerism amongst
the well off sections. Globally, this was sustained by a shift in power towards
capital and away from labour. This itself was a result of big changes in the
former Soviet Union and China
since the Seventies.
Today, the world is facing the specter of a double dip
recession with all major economies slowing down. This is impacting all the
economies including China
and India.
How can the impact of this brewing crisis be minimized? The lesson that India offers
from the period 2007-2010 is that government needs to intervene strongly in
favour of the poor and the marginalized sections. This would generate local
demand which would not leak out and would reduce inequity. Other developing
countries also need to increase local demand and reduce inequalities. Clearly,
the choice of sectors for increasing growth has to be based on those sectors
that have less linkages with external sector and low possibility of leakage of
demand. In other words, globalization has to take a back seat to local needs.
In this context, real wages have to be allowed to go up even thought that will
affect exports.
It must be understood that markets do not have a solution to
the current global problem since they cannot improve distribution. Further,
given the global crisis, lack of coordination amongst governments and a
conservative mood in most advanced countries, individual governments have
little control on the situation. The developing world cannot try to be the
market to enable the advanced countries to come out of the crisis since they
will themselves go down. Thus, there is little choice for the developing world
but to be more inward looking and protect its marginalized sections. Today,
government intervention has become the key to stable growth in the developing
world.
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