By Sathya Sahay and Clinton Manoti
“Ill fares the land, to hastening ills a prey, where wealth accumulates and men decay.”
- Oliver Goldsmith (18th Century Irish Poet and Playwright)
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Since time immemorial, societies have been plagued with economic inequality. In the 21st century of globalization, it is the greatest challenge facing the developing world. A 1992 World Bank report claimed that “. . . inequality is negatively and robustly correlated with growth”.[1] According to the International Monetary Fund, the balance has been redressed more recently, reflecting strong growth in many developing nations, particularly China and India. The UK ranks among the most unequal nations in Europe, but is more equal than the US, the most divided wealthy nation in the world. According to one ranking system (the Gini coefficient) South Africa is the most unequal country in the world. Scandinavian countries tend to have the lowest levels of inequality. As per the World Bank, Ukraine is the least unequal.
While some inequality is integral to the effective functioning of a market economy and investment incentives, it may also be destructive for growth by amplifying the risk of crises, making it difficult for the poor to invest in human capital and giving rise to political instability. Improved inequality can help sustain growth due to the increasing importance of human capital in development. “When physical capital mattered, it was important to have a large contingent of rich people who could save and invest in physical capital. Now that human capital is scarcer than machines, widespread education has become the secret to growth”. Evidence suggests that sustaining growth is significantly harder than igniting it. While even the African economic laggards have attained spikes in growth rates from time to time, what sets success stories apart; such as the Asian Tigers,[2] is the ability to sustain growth. IMF economists Andrew Berg and Jonathan Ostry explicate the simultaneity between inequality and unsustainable growth by proving that longer growth spells are robustly associated with greater economic equality.[3] For example, closing half the inequality gap in Latin America or emerging Asia would double the expected duration of their growth spells.[4] “Growth is Good for the Poor,” as increases in per capita income tend to translate into proportionate increases in the incomes of the poor. Sustainable growth; therefore, should be placed at the heart of poverty reduction, and since greater equality is essential for longer growth spells, developing economies must prioritize the reduction of resource disparity to accentuate growth.
A fundamental requirement for the functioning of an active democracy is political engagement by its citizens. The Relative Power Theory[5] asserts that more unequal societies lead to greater power concentration, which shapes the political landscape of the country. The large power advantage of the wealthier individuals allows them to consistently prevail in open conflicts and drown out the voices of poorer citizens, who find that issues actively debated are not relevant to them. The systematic removal of issues appurtenant to the poor from public discourse disincentivizes them from partaking in politics. The Conflict Theory hypothesizes a positive relationship, as high levels of inequality cause divergences in political preferences. In a more unequal society, redistributive policies become more appealing for the poor and less appealing for the rich. This clash of interests and rise in stakes fuels political mobilization and participation. The Resource Theory claims that whether inequality has a positive or negative effect on political engagement is dependent on income. It is derived from the view that engaging in politics requires resources, and people do so when they are willing to pay its costs. Hence, greater inequality should result in lower political engagement among the poor and greater among the rich. The effect of inequality on the political participation is self-reinforcing. It produces smaller, wealthier electorates, which in turn yield governments that reward wealthy citizens through less redistributive policies.
The suppression of political engagement due to inequality accentuates the need for developing countries to address the latter. As Schattschneider puts it:
“The struggle is no longer about the right to vote but about the organization of politics. Nonvoting is related to . . . the attempt to make the vote meaningless . . . we assume that the fight for democracy was won a long time ago . . . The battle for democracy is still going on but has now assumed a new form”.
The strength of a nation lies in the health of its people and the functioning of the society in which they live. There has been a negative causal relationship between inequality and life expectancy or infant mortality. “The difference in average life expectancy between a relatively egalitarian and inegalitarian society is . . . ten years.” Economic inequality adversely affects a host of social indicators, such as crime, violence, schooling outcomes, racism, drug abuse, mental illness, and status of women.[6] While greater equality makes the most difference to the rates of problems among the least well-off; these rates also reduce among the top quartiles of education or income. The forms of social dysfunction associated with greater inequality are; thus, not confined to the poor. These relationships reflect the sensitivity of health and social problems to the scale of social stratification underpinned by societal differences of material inequality. With most developing countries plagued with health inadequacies and social complications, it is important to not only address these problems directly through government programs, but also to mitigate their root cause of inequality.
Economic inequality adversely affects the three most fundamental dimensions of a nation: the economic, the political and the social. Inequality has adverse impacts on the environment, social cohesion, political stability, institutional quality and the happiness of citizens. Thus, whether the ultimate goal of the government of a developing country is as complex as sustaining economic growth; or as simple as producing happier citizens, it is imperative to implement policies promoting economic equality.
Progressive taxation is hailed as the most effective redistributive mechanism to combat economic inequality. Piketty highlights the growth of inequality in the west during the 19th century, which was halted and reversed between 1914 and 1945 as the assets of large capital-owners took a hit due to the World Wars and the Great Depression. Piketty[7] and Kuznets[8] acknowledge that the rise of progressive income taxation during the inter-war years was partly responsible for why top capital incomes and concentration never fully recovered from the shocks to reach their pre-war level. Recent studies find progressive taxation to be effective in reducing absolute inequality when taxes are not evaded and transfer payments and social safety nets result in redistributive government spending.
Technological development raises demand for skills. However, its impact on inequality depends on whether the supply of skills is growing at a faster or slower rate. In most developing countries, the supply of skills is losing this race due to the incapability of its educational institutions to equip the workforce with adequate skills. The highly skilled few earn exorbitant amounts and accumulate wealth, while the masses are left behind. To address this, governments must ensure greater access to formal education for the less-privileged and invest in education and skill-oriented job-training targeted towards low-skilled workers to help boost their productivity potential and future earnings. Since “. . . widespread education has become the secret to growth”, policies must aim to fillip skill supply and educational standards.
Governments must provide adequate and well-functioning social safety nets including unemployment benefits, universal healthcare, and subsidized education and food grains to ensure that its poorest citizens are guaranteed a bare minimum standard of living, allowing them to take advantage of labour market opportunities. Prevailing corruption and government inefficiencies must be remedied to ensure that benefits from government programs are in-fact delivered to the intended beneficiaries without leakages. Successful intervention programs such as India’s MGNREGA or Mid-Day Meal Scheme can serve as models for other developing nations to learn from. Lastly, since large proportions of the lower rung of the workforce in most developing countries are employed in agriculture, investments and subsidies towards this sector must be prioritized to boost agricultural productivity and profits; thereby enhancing the welfare of the worst off.
Economic inequality is holding back developing nations from achieving their true potential. Due to its adverse economic, political, social, medical and even moral implications; on not just the worst off, but on the nation as a whole; today, the developing world is faced with a challenge that it must address through pro-active government intervention. If the developing are to truly develop; economic inequality must become a phenomenon of their past belonging to particular places and times, not to a nation’s population for eternity.
Footnotes
[1] Here, growth refers to growth rates in GDP per capita.
[2] The Asian Tigers refer to the highly developed, industrialized countries of Hong Kong, Singapore, South Korea and Taiwan.
[3] This result holds even after controlling for several other determinants of duration of growth spells such as increases in human capital and physical infrastructure, financial development, trade liberalization, international financial integration, competitiveness and export structure, macroeconomic volatility and external shocks.
[4] Berg and Ostry (2011) hypothesize three channels through which economic inequality impacts duration of growth spells: 1) Credit Market Imperfections, 2) Political Instability, 3) Concentration of Economic and Political Power. At the end of the paper, the authors back up the results through empirical evidence in the context of developing economies such as Guatemala, Cameroon, Nigeria, Ecuador and Panama.
[5] The Relative Power Theory is also known as the Schattschneider Hypothesis.
[6] They collate studies over the last two decades and their data spans 23 countries and all 50 U.S. States.
[7] “The Kuznet’s Curve, Yesterday and Tomorrow” by Thomas Piketty is replicated in Chapter 5 of Understanding Poverty by Banerjee, Benabou and Mookherjee.
[8] Kuznet’s acknowledges the role of progressive taxation in containing economic inequality in his 1954 AEA Presidential Address.
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