The Telegraph
Since 1st March, 1999
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Are economic growth and equity contradictory goals' The early development economists thought so. The primary reason being that pushing up the economic growth rate of a country requires a rise in the savings and investment rate. Since the rich have a higher capacity to save compared to the poor, redistribution of income towards the poorer sections would reduce national savings and investment. This would bring down the rate of growth of the economy. So economists would argue for accepting greater inequality as a necessary price for achieving a higher growth rate.

The recently published World Bank's World Development Report 2006, however, has made a departure from this traditional view. Though it is still believed that there could be a short-run trade off between growth and equity, in the longer run, greater equity may help raise the rate of growth. Coming from the World Bank, this focus on equity ' as an important instrument of growth ' is rather surprising. World Bank views do influence the thinking of policy- makers in many countries. So, it is important to follow its logic.

But let us first understand 'equity'. The majority opinion today among development economists is that equity basically implies equality of opportunity, not equality of outcomes. So even a high degree of observed inequality in income or in standard of living (an outcome) could be consistent with equity in the sense of equality of opportunity. Individuals, because of their intrinsic differences in abilities, talents, work efforts or sheer luck, would end up differently, even with the same opportunities. Nothing wrong with that. What is wrong are privileges based on birth, gender, race, religion, caste and so on.

But the WDR 2006 definition of equity has a second pillar. Even with equality of opportunity, some people would fall below a socially accepted poverty line due to deficiency in efforts or old age or ill health or natural calamities or plain bad luck. Therefore, equity requires that the people who end up at the bottom of the ladder be taken care of by a social safety net.

How does greater inequality lead to lower long-term growth rate' The explanation runs in terms of market failures, specially in credit, insurance, land and human capital markets. For example, in a perfect capital market, even a poor person with no capital can easily borrow unlimited funds from the market and invest. But in reality, the poor do not have access to bank finance or have access only at very high interest rates whereas the opposite is true for the rich. This is either due to the lack of collaterals with the poor or high transaction cost or because the poor do not have the political/social connection to arrange for a loan. As a result, investment projects with higher rates of return that could have been undertaken by poor entrepreneurs are not taken up, while those yielding a lower return are undertaken by the rich. The rich often do not even repay the loans to state-owned banks. Capital is thus used inefficiently and growth suffers.

The poor face similar problems in other markets (insurance, human capital, land) too because they cannot afford to buy private insurance nor do they have a social safety net against variable incomes or loss of jobs. Not only is growth adversely affected, equity also suffers through the vicious circle of a poor family remaining poor over generations through perpetuation of unequal opportunities. In the land market, many actual tillers do not have property rights to the land. This blunts their incentive to make long-term improvements in the productivity of land. Again, efficiency suffers due to inequities.

The absence of a social safety net also makes it difficult to restructure industries in line with changing global market opportunities. Restructuring would lead to loss of jobs in the sunset industries (say, jute) even if it causes job gains in sunrise industries in other places (say, IT). Hence a fair and speedy compensation mechanism as well as retraining facilities for the laid-off workers are needed. Otherwise the economy would be deprived of the flexibility so essential for rapid economic growth.

Inequality (in opportunities and outcomes) has many dimensions ' interpersonal, inter-regional, inter-gender, inter-caste, inter-country, and so on. Further, inequality can be perceived in terms of unequal distribution of wealth, income, consumption expenditure, powers and privileges and participation in the decision-making process. While inequality is a relative measure, poverty ratio is an absolute measure defined as the percentage of people below a poverty line income or expenditure. In many cases, the poverty measures and the various inequality measures may move in different directions.

For example, in the post-liberalization period, inequality in terms of income distribution has gone up while the percentage of people below poverty line has gone down in both India and China. This is not surprising. Faster growth is usually associated with more job creation and some of the benefits do accrue to even the poorest ' as producers, employees and consumers ' specially if the inflation rate is kept low. That means reduction in poverty ratio.

At the same time, liberalization and growth open up more market opportunities. The richer and better endowed individuals can exploit these opportunities more than the less privileged, creating greater interpersonal inequality. Further, private investment would go to areas which offer better investment climate, accentuating regional imbalances. However, liberalization may also unleash a force in the opposite direction. Some laggard states may try to improve the investment climate in an attempt to attract more private investment. To that extent regional disparity may tend to go down.

It would be interesting to note the contrasts between China and India in this context. The population below $1 day international poverty line was 35.3 per cent in India in 1999-2000 whereas it was 16.6 per cent in China in 2001. Clearly, China's performance is much better in poverty alleviation. But the picture on inequality is totally different. The Gini Index of inequality (a measure of deviation from perfectly equal distribution) was 33 in India in 1999-2000 while it was 45 in China in 2001. So, India has far lower inequality than in China. This might appear surprising, given the level of state ownership and control in China. But few countries have witnessed such a huge rise in inequality as in China, a fact often overlooked.

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