“Impact of Inequality on Growth”

03 Jun “Impact of Inequality on Growth”

This article covers “Daily Current Affairs” and the topic details of “Impact of Inequality on  Growth”. This topic is relevant in the “Economy” section of the UPSC- CSE Exam.

Why in the news?

Many voices contend that inequality poses a threat to democratic processes. On the contrary, some argue that a certain degree of inequality serves as a catalyst for entrepreneurship, stimulating business creation and thereby enhancing employment opportunities and overall welfare. However, this perspective overlooks the adverse economic repercussions of inequality. One significant aspect is the concentration of monopoly power within capital compared to labor, which can detrimentally impact consumption, welfare, and economic growth. Implementing equitable wealth taxation and distribution measures, if executed effectively, can yield positive economic outcomes.

How Monopoly Reduces Investment and Consumption:

• Billionaires amass their wealth through monopolistic control in their respective markets. Their conglomerates hold dominant positions, enabling them to dictate prices rather than being subject to market forces. 
• The degree of mark-ups above production costs is dictated by their monopoly influence. Consequently, in economies with entrenched monopolies, real wages—determinants of purchasing power—tend to be depressed. 
• These effects of monopoly are currently manifesting in the form of cost-of-living crises in developed economies. The phenomenon termed “greedflation,” wherein companies hike prices to bolster profit margins amidst multiple demand-and-supply shocks triggered by the pandemic, has been identified as a contributor to high inflation rates in the West.
• Economic theory illustrates that under a monopoly, the profit-maximising output level is lower than in a competitive market, implying a loss in welfare. Thus, the prevalence of monopolies can lead to reduced real wages, diminished output levels, and lower levels of investment.

Relation between Inequality and Growth:

• Consider a scenario where a company opts to establish a new factory. Before the new capital stock is realised, wages are disbursed to labourers for construction.
• The income earned by workers is then spent on goods, thereby augmenting the income of goods-sellers, who in turn increase their spending on other goods, perpetuating a cycle. This process, known as the ‘multiplier’ effect, results in an overall increase in incomes greater than the initial investment.
• However, when firms wield market power, mark-ups and prices tend to be inflated. Consequently, real wages decrease, leading to reduced purchasing power. 
• While companies enjoy higher profits due to inflated margins, the increase in income resulting from a given investment is lesser under a monopoly due to reduced consumption power. Consequently, investment’s stimulatory effect on growth is weaker under monopolistic conditions, albeit not affecting profits.
• One could argue that the consumption of the wealthy can fuel economic growth. However, despite their higher absolute consumption, the wealthy apt to allocate a smaller proportion of their incomes towards consumption. 
• The multiplier effect hinges on the proportion of income devoted to consumption. In an unequal economy, lesser incomes in the hands of those with a higher propensity to consume lead to a weakened expansion in the economy.

Relation between the accumulation of wealth and Investment:

• Some contend that the remedy of redistribution may prove more detrimental than the ailment of inequality by stifling job creation. 
• High-tax regimes may dampen entrepreneurs’ incentives to amass wealth, leading to decreased investment and job opportunities. However, a distinction must be drawn between wealth and profits. 
• Investment decisions are guided by expectations of future profits, whereas wealth accumulates from past profits. Taxes on wealth, as argued by economist Michal Kalecki, do not necessarily impact investment since they leave profit expectations unchanged. 
• For instance, taxing Gautam Adani’s wealth would not directly affect investment in airports, as the demand for air travel remains independent of his wealth’s value.

Undoubtedly, the difficulty in converting profits into wealth may dissuade some business owners from undertaking investment. Nevertheless, an economy with high-profit expectations would incentivise businesses to invest even in the face of wealth taxation. Redistribution can stimulate growth by strengthening the multiplier process through increased income. Businesses are more inclined to invest where purchasing power is robust. Additionally, if monopolies are curbed, prices would decrease, and real wages would rise, leading to heightened demand.

Thomas Piketty’s proposal to tax billionaire wealth and provide basic income may lead some individuals to exit the economy. However, it can also foster a new wave of entrepreneurs who are liberated from the necessity of wage labour. Redistribution alone is not a panacea, and excessively high tax rates can become an economic burden. Nonetheless, when employed in conjunction with other policy measures, addressing inequality can pave the way for a more robust economy.

Some measures needed to reduce inequality:

• Boosting Employment and Wages:   

         – Investing in infrastructure to create job opportunities.

         – Reduce the cavity between labour demand and supply through skill training.

         – Promoting labour-intensive exports and supporting small enterprises.

         – Ensure social security and fair working conditions for all.

• Advancing Human Development:

         – Increasing public expenditure on healthcare and education.

         – Prioritizing initiatives to improve health and education outcomes.

• Establishing Social Safety Nets:**

        – Implementing programs like the Mahatma Gandhi National Rural Employment   Guarantee Act (MGNREGA) to enhance livelihood security.

        – Providing accessible and affordable healthcare services through initiatives like the National Health Mission (NHM).

        – Promoting gender equality through campaigns like Beti Bachao Beti Padhao.

• Addressing Urban-Rural Disparities:

       – The Pradhan Mantri Awas Yojana (PMAY) and Swachh Bharat mission focus on providing affordable housing in both urban and rural areas.

       – Bridging the gap in living standards and infrastructure between urban and rural regions.

The aim of these programs is to create a more equitable society in India by providing equal opportunities for all individuals to flourish and contribute to the nation’s progress. Initiatives like social welfare schemes, educational programs, healthcare services, and employment generation efforts play a crucial role in reducing inequality and fostering inclusive growth and social harmony in the country.

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Prelims based Question:

Q.Consider the following statement regarding inequality prevailing in the country:

1. Redistribution of wealth always leads to reduced inequality and increased GDP.
2. Investment’s stimulatory effect on growth is weaker under monopolistic conditions, albeit not affecting profits.

Which of the following statement/s above is/are correct?

1. 1 only
2. 2 only
3. Both 1 and 2
4. Neither 1 nor 2

Answer: B

Mains based Question:

1. Redistribution of wealth is not the panacea to address the inequality that persists in an economy. How can we ensure the reduction of inequality through better redistribution of resources? Discuss.

Vishal Yadav