Pro-poor policies yield rich dividends

Janakraj Gupta

In the recent past, three reports that have come out show the grave implications of the development path which India has been following since 1991. All these reports have highlighted the plight of the poor and the importance of reducing distributional inequalities. The first report titled “Socio-Economic and Caste Census for Rural India” was released by the Union Rural Development Ministry on July 3, 2015. This census report revealed a grim picture of rural India. It was pointed out that 75 per cent of rural households have less than Rs. 5,000 per month income. For an average family size of five members, this will amount to less than Rs 1,000 per capita. 

The second study, by Boston Consulting Groups, the “Winning the Growth Game : Global Wealth 2015,” has revealed that the country's 20 per cent wealth has accumulated in the hands of 928 houses. The top 10 per cent Indians own 74 per cent of country's personal wealth, while the remaining 90 per cent share hardly one-fourth. The third study,  but the most significant one is by the IMF (International Monetary Fund), the international agency for formulating economic policies. The latest findings of IMF have rejected the “trickle-down theory,” which it along with the World Bank had propagated earlier. The research under the title, “Causes and Consequences of Income Inequality: A Global Perspective,” has been conducted by a team of IMF's economists, Era Dabla-Norris, Kalpana Kochhar, Nujin Suphaphiphat, Frantisek Rica and Evrdiki Tsounta. Their research show that more money in the hands of poor promote development at higher rate than if it is put at the disposal of rich. The study is based on 159 countries and has covered a period of 1980-2012. The IMF study shows that “why policy makers need to focus on the poor and the middle class.” 

Earlier IMF work had shown that income inequality matters for growth and its sustainability. The latest analysis, however, suggests that the income distribution itself matters for growth as well. “Specifically, if the income share of the top 20 per cent (the rich) increases, then the GDP growth actually declines, suggesting that the benefits do not trickle down. In contrast, an increase in the income share of the bottom 20 per cent (the poor) is associated with higher GDP growth. The poor and the middle class matter the most for growth.” The study is logical in the sense that the poor spend all increase in their income, which would have a multiplier effect on economic growth. 

Even increase in the income of the middle class who have a positive propensity to save, would be kept in safe channels which will find outlets in productive investment. It is only the billionaires and millionaires who resort to ostentatious consumption. Elaborating further, the findings suggest that “policies that focus on the poor and the middle class can mitigate inequality. Irrespective of the level of development, better access to education and health care and well targeted social policies can help raise the income share for the poor and the middle class.” Earlier too the IMF had sounded an alarm about the growing chasm between the rich and the poor and warned that “rising increase in inequality  is weighing on global economic growth”. 

The latest study of IMF is an eye opener in economic development history since till today the predominant thinking was that more money in the hands of rich implies more savings and investments, therefore, more employment and income.  That is inequality in income distribution was considered panacea for development. This thinking had induced many countries to adopt this approach commonly known as structural adjustment programme (SAP). India too had to follow this approach after 1991, under the pressure of the IMF and the World Bank. Therefore, in the light of new findings our policy makers have to rethink and redesign policies accordingly. 

The other drivers of growth which could  have salutary effects on reducing dispersion of income, identified by the IMF study are : human capital and skill, financial inclusion and incentivising the informal sector to convert it into the formal sector. According to the IMF study, education is the key and raising skill levels is critical to reduce dispersion of earnings. To make a dent in inequality, financial deepening needs to be accompanied by greater inclusion. Informal firms should be encouraged through tax and financial incentives to become formal. In order to ensure that the fruits of prosperity are more broadly shared, agricultural productivity must be raised and technology diffusion in labour-intensive sectors must take place.  

Then, of course, fiscal policy could be an important tool to reduce inequality. Fiscal redistribution can help raise the income share of the poor and middle class, and thus support growth. But the redistributive role of fiscal policy could be reinforced by greater reliance on wealth and property taxes, more progressive income taxation, removing opportunities for tax avoidance and evasion and better targeting of social benefits. 

In addition, reducing tax expenditures that benefits high-income groups most and removing tax relief such as reduced taxation of capital gains, stock options, and carried interest would increase equity. “Better access to education and health services, well-targeted conditional transfers and more efficient safety nets can have a positive impact on disposable income of the poor.” 

Considering IMF findings, one is disillusioned to find the policy shifts of the new government. Let us first examine the current 2015-16 budget. Being the first full-fledged of the new BJP government, it could reveal the new policy approach. Wealth tax stands abolished. Corporation tax on profits has been proposed to be cut to 25 per cent from the existing 30 per cent over the next four years. Social sector spending for the poor, comprising education, health, social-security, food-security, drinking water, scheduled castes/tribes, etc. has been slashed by nearly Rs 1.75 lakh crore for the year 2015-16 alone. Agriculture too, which has been identified as the main driving force to reduce distributional inequalities, has been left out. 

Even the most respectable social programme under the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) was not spared. With a reduced allocation Rs 34,699 crore and tardy release of funds, this programme is heading towards a quiet burial. These cutbacks were so drastic that even NDA's own cabinet ministers felt compelled to lodge complaints with the Finance Minister, Arun Jaitley. 

In the light of the latest findings, the time has come for revised and reoriented strategic policies of income distribution to strengthen the economic base of the poor. Time is running out. Less than four years are left for the present government to sow the seeds of a shift in economic policies. Since the latest IMF approach is more pro-poor, its adoption can yield dividends for the new government.

The writer is former Professor and UGC Emeritus Fellow, Department of Economics, Punjabi University, Patiala