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Equality or Not?

A Look at Economic Equality in India from 1947-2012

By Varun Desai Professor Srilata Gangulee SAST057-301 December 25, 2012

Introduction Democracy in India has come a long way since the country gained its independence from the British Empire on August 15, 1947. In the six and a half decades since economic growth in India has been very strong and Indias economy is projected to become the worlds third largest by 2035. The agricultural sector has progressed significantly while the manufacturing industry has been established. The tertiary sector has also been developed, and recently, the quaternary sector (consisting of knowledgebased industries such as the information technology industry) has become a powerhouse with the growth of calling centers outsourced from the U.S. and other rich nations. Other things, including a very popular cuisine and a prolific cinema industry in Bollywood, have raised India up to unprecedented levels of economic growth for developing countries. However, India is still dealing with a massive stumbling block in its quest for economic development: economic inequality. 75% of India is considered to be in danger of being poor, while about 30% of Indias population is currently considered to be abjectly poor (consuming less than $1 US/day per person in the household) (Sengupta, Kannan, and Raveendran). Furthermore, figures have shown that income inequality, though it has decreased since 1947, is once again increasing. Recent studies show that in 2012, the urban Gini coefficient in India rose from 0.35 to 0.65 (Mehta). Thus, India still needs to find a solution through its income distribution and economic equality policies. In this paper, by examining income distribution data for India since 1947, I will discuss the issue of economic inequality in India, the effect of the 1991 fiscal reform on economic inequality, and the effect of corruption on income distribution. Measuring Income Inequality Income inequality is defined as the unequal distribution of household or individual income across an economy. There are various ways in which income inequality is measured. One such method is the Lorenz Curve of income distribution, which graphs the cumulative percentage of total income against the cumulative percentage of households. An economy with perfect income equality has a Lorenz curve in the shape of a 45-degree line. A good way to measure the state of income inequality using the Lorenz Curve is through the Gini coefficient, which is the ratio of the area of the Lorenz curve to the are underneath the line of perfect equality (45-degree line). A Gini coefficient of 0 means a perfectly equal economy while a completely unequal society has a Gini coefficient of 1. Both the urban and rural Gini coefficients in India have stayed consistent for the latter half of the 20th century. However, the urban Gini coefficient rose from 0.330 in 1983 to 0.341 in 1999-2000 while the rural one actually decreased from 0.299 in 1983 to 0.258 in 1999-2000, as shown in the table below.

Source: http://www.un.org/esa/desa/papers/2007/wp45_2007.pdf Similarly, urban and rural Gini coefficients stayed fairly even in the beginning of the 21st Century, but the urban Gini coefficent has slightly risen:

Source: http://www.un.org/esa/desa/papers/2007/wp45_2007.pdf

When compared to the rest of the world, Indias overall Gini coefficient is very good. It is said to be somewhere around 0.30, which is lower than USAs Gini coefficient, which, from 2006-2010, was 0.467 (Bee). However, the startling fact is that Indias urban Gini coefficient has continued to rise and jumped in 2012 to 0.65 (Mehta). This does not bode well for India, whose population is urbanizing very quickly. Thus, it seems that the urban Gini coefficient will rise even more in the future, spelling more trouble for India in terms of economic equality. Poverty While the Gini coefficient is a good indicator of economic inequality, there are also others, such as poverty rates. There are two main types of poverty: relative and absolute poverty. The relative poverty threshold is related to the quality of living within the country. However, absolute poverty is defined as the level under which it is impossible to consume the minimum amounts of food, clothing and shelter needed to survive. According to the Indian Planning Commission, poverty is defined as Rs. 49/month per capita in rural areas and Rs. 57/month per capita in urban areas (all figures in terms of 1973-74 prices). According to this definition, the number of poor people in India in 1950, according to World Bank, was about 200 million. In 1993-1994, the number increased to 312 million (World Bank). On the other hand, the population of India in 1950 was estimated to be about 369 880 000 and around 846 303 000 in 1991 (Kulzick, Adlakha). Thus, it can be clearly seen that while the absolute number of people living in poverty increased, the percentage of the population in poverty has decreased. India has managed to decrease the percentage of the population under poverty, but the rate at which it has managed to do so is very low. Another method of calculating poverty is the one proposed by Arjun Sengupta and others in the March 15, 2008 edition of Economic and Political Weekly. They classify types of poor people in terms of Monthly Per Capita Expenditure (MPCE) and the poverty line. If the Monthly Per Capita Expenditure of the person is less than 75% of the poverty line, then the person is deemed to be extremely poor, persons between 75% and 100% of the poverty line are considered poor, between 100% and 125% of the poverty line are considered marginal poor, and persons between 125% and 200% of the poverty line are considered vulnerable poor. Anything above this level and up to 400% of the poverty line are considered the middle class, while anything above 400% is considered the high income group. The monetary value of the poverty line established changes in accordance with data from the Consumer Expenditure Survey, done every 5 years by the Planning Commission (Sengupta, Kannan, and Raveendran). The percentage of the Indian population classified as vulnerable poor or lower has decreased by around 5% from 1993-1994 to 2004-2005. There has also been a drastic reduction in the extremely poor class (from 11.5% of the population in 1993-94 to only 6.4% of the population) and the poor class (19.2% in 1993-94 to 15.4% in 2004-2005). Also, the middle class has seen a slight increase in size (from 15.5% of the population in

1993-94 to 19.3% in 2004-05), thus demonstrating that there is some income redistribution occurring in the Indian economy (Sengupta, Kannan, and Raveendran).

Source: Economic and Political Weekly

However, a huge percentage of Indias total population, nearly 76.7%,was still classified as vulnerable poor, marginal poor, poor, or extremely poor in 2004-2005. Furthermore, a middle-class and higher population consisting of only 23.3% of the entire population (as of 2004-05) may not be able to sustain the high rate of economic growth in India (Sengupta, Kannan, and Raveendran). Unless greater measures are implemented to combat income inequality, the poor will languish in a phenomenon known as the poverty cycle, a positive feedback loop that states low income will lead to low private savings. These low savings mean that there wont be enough money for private investment, which will lead to lower productivity in the overall economy. Lower productivity will once again lead to lower income as the cycle starts again. Income Redistribution One of the best ways to combat income inequality is through income redistribution. This can take many forms, including transfer payments in the form of welfare and social security. However, in order to generate enough funds to redistribute income, a strong tax base is needed. Unfortunately, Indias tax base is insufficient and further exacerbates the level of income inequality within the country. 1991 Balance of Payments Crisis Effect Public vs. Private Sector Indias economy consists of two sectors: the public and private sector. In 1947, India initially started with an economy that was highly planned. The majority of the industries, including heavy industries like coal and oil and financial sector industries like banking, were nationalized. On the other hand, consumer goods were manufactured in the private sector of the industry. In 1991, after a huge balance of payments crisis, India underwent a series of economic reforms that included the deregulation of many of the government industries that were incurring losses. The private sector ended up playing a bigger role in the economy. But it also has played a big role in increasing economic inequality in India. The pay scale in the public sector is very well organized. It is hierarchical in the sense that certain jobs get paid more than other ones, but there is transparency within the income received by workers for their jobs. However, the majority of the private sector is comprised of many family businesses whose incomes are often underreported. There is less transparency within the process, which contributes to an inefficient taxation system, thereby exacerbating income inequality. The 1991 economic reforms may have increased economic inequality. The deregulation of the public sector would shift many jobs from the public pay scale to the private scale. Thus, there would be less transparency about the income earned by these businesses, resulting in inefficiency within the tax system via tax evasion. As a result, the tax base would significantly decrease, resulting in a smaller redistribution of income and

greater income inequality. This may partially explain the steady rise in the urban Gini coefficient, since many of these private businesses are located in urban areas. Taxation and Income Inequality As well, the 1991 economic reforms also carried other implications. The high deficit was considered to be bad for the economy because it would put inflationary pressures on the economy and lead to high interest rates. This has the potential to crowd out private investment, which coupled with high public debt, could have been disastrous for the economy. As a result, the Indian government emphasized a reduction in direct tax rates to stimulate private investment within the country. Since these direct tax rates are progressive (percentage of taxation increases with the amount of income), the tax cuts provided more benefits to the rich than the poor, resulting in greater income inequality in India (Pal and Ghosh). Furthermore, indirect tax rates on import duties and tariffs were done to liberalize trade in 1991. This ended up further decreasing the tax base, meaning that the balance of payments deficit could have only been managed by cutting expenditure rather than by increasing the tax base. Most of these expenditures were often in public projects and social and welfare programs that often benefited people with lower incomes rather than those with higher incomes. As a result, projects on infrastructure and agricultural development were eliminated, increasing income inequality and widening the income gap even further (Pal and Ghosh). In addition, there was a reshuffling of tax power between the state and federal governments. After 1991, the federal government introduced a Value-Added Tax (VAT) and a Central Sales Tax. These taxes ended up decreasing the states share of the tax base, which ended up decreasing their ability to spend on public services. Since state taxes were often used to fund infrastructural and agricultural development, this further decreased resources in the agricultural industry, thereby increasing rural poverty and unemployment (Pal and Ghosh). Spending Cuts and Inequality These spending cuts were especially significant in the primary sector. In the 1980s, there was a huge emphasis on increasing rural employment. The government spent a significant amount of money within the agricultural sector for diversification and rural employment, which would decrease rural poverty. As a result, the rural Gini coefficient decreased significantly. After the 1991 crisis however, rural development was halted due to the aforementioned spending cuts to balance the budget. Thus, the progress achieved through increased employment and reduced poverty levels was halted (Chandrasekhar and Ghosh). Food subsidies, along with subsidies for fertilizer and export subsidies, were also cut. This decreased the supply of food grains produced within the market, which had a catastrophic effect on the Public Distribution System for grains for vulnerable households. However, the decline in these subsidies resulted in a new system called the Targeted Public Distribution System (TPDS), which only provided subsidized cost to

households below the poverty line. On the other hand, those who were Above Poverty Line (APL) saw a rise in food prices, which were now 180% of the original price (Pal and Ghosh). As a result, the rise in food prices itself became a form of regressive taxation (since marginal poor and vulnerable poor households would have food a greater percentage of their income in comparison to middle-class and upper-class households). Thus, the 1991 balance of payments crisis resulted in greater income inequality in India. Due to the deficit-reducing policies of India in 1991, the tax revenue base took a giant hit, while government spending was diminished quite significantly, reducing Indias tax revenue to GDP (Gross Domestic Product) ratio from around 10.1% in 1990-1991 all the way down to 8.6% in 2001-2002 (Reserve Bank of India). The following data table details the tax revenues as a percentage of the GDP from 1990-2002: Table: Tax Revenue as Percentage of Indian GDP from 1990-2002 Year Income Tax Corporation Tax 0.9 1.2 1.2 1.2 1.4 1.4 1.4 1.3 1.4 1.6 1.7 1.6 Excise Duty 4.3 4.3 4.1 3.7 3.7 3.4 3.3 3.2 3.1 3.2 3.3 3.2 Custom Duty 3.6 3.4 3.2 2.6 2.6 3.0 3.1 2.6 2.3 2.5 2.3 1.8 Total 10.1 10.3 10.0 8.8 9.1 9.4 9.4 9.1 8.3 8.9 9.0 8.1

1990-1991 0.9 1991-1992 1.0 1992-1993 1.1 1993-1994 1.1 1994-1995 1.2 1995-1996 1.3 1996-1997 1.3 1997-1998 1.1 1998-1999 1.2 1999-2000 1.3 2000-2001 1.5 2001-2002 1.4 Source: Reserve Bank of India

While there has been a slight increase in the income tax and corporate tax revenues over the years, the decline of the excise and customs duties (resulting from greater trade liberalization in 1991) has resulted in an overall decrease in the tax revenue to GDP ratio. Thus, since the ratio is lower, the tax base is unable to affect either income distribution or provide adequate funding for public programs. Hence, as a result of the previously mentioned reasons, the 1991 economic policies have had a negative impact on economic inequality in India. Corruption While India has experienced enormous amounts of economic growth, it has not been a clean growth. Factors hindering economic development and economic equality have caused many problems. One of these problems is corruption. More often than not, different forms of corruption, such as bribery, cronyism, nepotism, and embezzlement, have become common themes in Indian politics.

India has 6.9% of the worlds billionaires as of 2012, but the GDP of India only makes up 2.1% of the worlds total GDP. These billionaires account for nearly 20% of the 2.1% (Sardana). Clearly, there is a wide economic gap between the rich and the poor in India. This gap is further exacerbated by corruption. Corruption is often seen as a barrier to economic development as it discourages foreign investment. It also leads to tax evasion since firms, especially in the private industry, engage in hidden bookkeeping to hide bribery. Corruption also promotes crony capitalism (government favoring family members and friends by offering them government contracts and licenses), bribery, distorts government policies and skews public funds away from valuable social programs (health and education), and increases capital flight and misuse of funds which increase the burden of debt. All of these problems have the potential to further increase economic inequality. Decreased foreign investment will lessen the opportunity for the poor to break out of the vicious poverty cycle. Tax evasion, as already mentioned, can lead to income inequality by shrinking the tax base and keeping the concentration of wealth among the rich. Crony capitalism can often lead to inefficiencies in the market because the most productive and suitable candidates are foregone for family members and friends who are often the rich trying to get even richer. Bribery acts as another tax on business and often hits the poor the hardest since the marginal benefit from a dollar is higher for them than for the rich. Thus, bribery becomes an almost regressive tax as it skews economic equality even further. India placed 94th out of 183 countries in the worlds most corrupt countries. India received a score of 36 on a scale from 0 (most corrupt) to 100 (least corrupt), ranking below countries such as Sri Lanka and also China, the country with which India is most often compared with since both India and China underwent political reform in the 1940s. This was a significant drop from 2010, when India was ranked 72nd in terms of corruption (The Hindu). However, recent scandals have highlighted the severity of corruption and the effects that it has on redistribution within the country. One of these scandals exposed corrupt officials in the state of Uttar Pradesh, who have robbed as much as $14.5 million worth of food for families within the state. As well, private contractors have stole almost $2 billion worth of food supplements intended to feed children as part of the Integrated Child Development Services (ICDS) program. There were claims that food often wasnt delivered and if it did, it was missing the vitamins and nutritional elements promised within the supplements. In some cases, the food wasnt even edible. Meanwhile, government officials provided falsified information to the media, claiming the food services programs had no private contractors and up to 90 to 95% of the food was delivered to their location (Overdorf). Policies that promote economic equality are largely ineffective as a result of these forms of corruption. The following is a list of the most corrupt states in India. They are broken off into four categories: alarmingly corrupt, very highly corrupt, highly corrupt, and moderately corrupt:

Table: List of Most Corrupt States in India Category Alarmingly Corrupt Alarmingly Corrupt Alarmingly Corrupt Alarmingly Corrupt Very Highly Corrupt Very Highly Corrupt Very Highly Corrupt Highly Corrupt Highly Corrupt Highly Corrupt Highly Corrupt Highly Corrupt Highly Corrupt Moderately Corrupt Moderately Corrupt Moderately Corrupt Moderately Corrupt Moderately Corrupt Moderately Corrupt Moderately Corrupt Source: Rediff News State Bihar Jammu and Kashmir Uttar Pradesh Madhya Pradesh Karnataka Rajasthan Tamil Nadu Gujarat Chhattisgarh Delhi Jharkhand Kerala Orissa Andhra Pradesh Haryana Himachal Pradesh Maharashtra Punjab Uttarakhand West Bengal

There is a positive correlation between economic growth and level of corruption. Among all these states, Gujarat is an interesting state to analyze. It is one of the Highly Corrupt states in India, yet it has also become one of the most efficient states. Chief Minister Narendra Modi has led Gujarat to levels of unprecedented growth, making it the friendliest destination for domestic investors. Gujarat has increased the presence of the auto industry through better land-acquisition policies, infrastructure, and industrialized ports than those in Maharastra, Tamil Nadu, and Haryana, who previously housed a strong auto industry presence. Modi has promoted the manufacturing sector while at the same time maintaining a good rate of growth within the agricultural sector, reaching levels of 10% growth from 2002-2012. Meanwhile, India itself as a country has only managed to grow its agricultural output by 4% during that time span (Nayyar). Similarly, Bihar, though it has an alarmingly high level of corruption, has also made great strides in achieving economic growth. Bihar has registered a growth rate of over 10% over the past seven years, which is second only to Gujarat during that time span. Chief Minister Nitish Kumar has increased construction of roads through public spending and is on pace to make Bihar into a sustainably developed state (Nayyar). Economic growth is still rampant in these states despite high levels of corruption. On the other hand, West Bengal, one of the least corrupt states, is also one of the least

economically efficient ones, often experiencing long waiting times and slow governmental progress. The argument is that corruption in states like Gujarat and Bihar breeds efficiency because it is done on all levels of the government, thereby not negatively impacting a specific party. Nevertheless, there is no denying the fact that its effect on economic equality, the focus of this paper, are still negative, and needs to be controlled if India is to become more economically equitable. Conclusion Indias economy has certainly progressed quite far from its modest beginnings. A high rate of growth, a robust democracy, and a skilled workforce has made India into one of the strongest developing countries in the world. However, in order to achieve full economic development, India still needs to fully tackle the issue of income inequality within the nation. There has been a recent rise in the urban Gini coefficient since 1981 and the in the absolute number of poor since 1947. As well, the 1991 fiscal reforms, while they resolved the balance of payments crisis, have placed huge burdens on the goal of reducing economic inequality. Spending cuts and a decreased tax rates have limited the role of government in redistributing the income in the country. At the same time, corruption has distorted government assistance programs and shrunk the tax base via underreported incomes. Economic equality is still a long way away from being achieved. However, not all is bad news for India. There have been great strides made towards reducing inequality. There have been steady improvements in the overall Gini coefficient since 1981, having shrunk from 0.329 in 1987 to 0.320 in 1999-2000. As well, the percentage of the population in poverty has also shrunk. The United Nations plan to halve poverty in the world by 2015 has and will continue to benefit the Indian poor and hopefully release them from the vicious cycle of poverty. Though there have been many issues of income inequality, there have been steady signs of improvement that are pointing towards a better and more equitable future in India.

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