Inequality within most advanced and emerging markets and developing countries including India has increased and the phenomenon has received considerable attention. Widening income inequality i.e gap between the rich and the poor is a defining challenge in the recent time.
Equality, like fairness, is an important value in most societies. Irrespective of ideology, culture, and religion, people care about inequality. Inequality can be a signal of lack of income mobility and opportunity―a reflection of persistent disadvantage for particular segments of the society. Widening inequality also has significant implications for growth and macroeconomic stability, it can concentrate political and decision making power in the hands of a few, lead to a sub optimal use of human resources, cause investment-reducing political and economic instability, and raise crisis risk.
An IMF study found that there is an inverse relationship between the income share accruing to the rich (top 20 percent) and economic growth. If the income share of the top 20 percent increases by 1 percentage point, GDP growth is actually 0.08 percentage point lower in suggesting that the benefits do not trickle down. Instead, a similar increase in the income share of the bottom 20 percent (the poor) is associated with 0.38 percentage point higher growth. This positive relationship between disposable income shares and higher growth continues to hold for the second and third quintiles (the middle class).
Policymakers need to consider policies to tackle inequality. Raising the income share of the poor, and ensuring that there is no hollowing-out of the middle class is actually good for growth. Redistribution through the tax and transfer system is found to be positively related to growth for most countries, and is negatively related to growth only for the most strongly re distributive countries. This suggests that the effect of redistribution on enhanced opportunities for lower-income households and on social and political stability could potentially outweigh any negative effects on growth through a damping of incentives.
Fiscal policy can be an important tool for reducing inequality. Fiscal policy plays a critical role in ensuring macro-financial stability and can thus help avert/minimize crises that disproportionately hurt the disadvantaged population. At the same time, fiscal redistribution, carried out in a manner that is consistent with other macroeconomic objectives, can help raise the income share of the poor and middle class, and thus support growth. Better access to education and health services, well-targeted conditional cash transfers and more efficient safety nets can have a positive impact on disposable incomes of the poor. In many cases, this increasing public spending would need to be undertaken in tandem with rising revenue mobilization, reduced tax loopholes, and tax evasion, and lower less- well-targeted spending.
In a world in which technological change is increasing productivity and simultaneously mechanizing jobs, raising skill levels is critical for reducing the dispersion of earnings. Improving education quality, eliminating financial barriers to higher education, and providing support for apprenticeship programs are all key to boosting skill levels in both trade and non trade sectors. These policies can also help improve the income prospects of future generations as educated individuals are better able to cope with technological and other changes that directly influence productivity levels. In advanced economies, with an already high share of secondary or tertiary graduates among the working-age population, policies that improve the quality of upper secondary or tertiary education would be important.
In developing countries with currently low levels of education attainment, policies that promote more equal access to basic education could help reduce inequality by facilitating the accumulation of human capital, and making educational opportunities less dependent on socioeconomic circumstances. Financial deepening needs to be accompanied by greater inclusion to make a dent in inequality. Governments have a central role to play in alleviating impediments to financial inclusion by creating the associated legal and regulatory framework, supporting the information environment and educating and protecting consumers. Many country experiences also suggest that policies such as granting exemptions from onerous documentation requirements, requiring banks to offer basic accounts, and allowing correspondent banking are useful in fostering inclusion.
Moreover, it illustrates the broader point that deep social issues cannot be resolved purely with an infusion of credit. Policies thus need to strike a balance between fostering prudence stability, and inclusion, while encouraging innovation and creativity. Well-designed labor market policies and institutions can reduce inequality, and, at the same time, not be a drag on efficiency. Policies that reduce labor market imperfections and institutional failures that affect job creation can help support poor and middle-income workers. For instance, appropriately set minimum wages, spending on well-designed active labor market policies aimed at supporting job search and skill matching can be important. Better use of in-work benefits for social benefit recipients also help reduce income disparities. Moreover, policies that reduce labor market dualism, such as gaps in employment protection between permanent and temporary workers—especially young workers and immigrants—can help to reduce inequality, while fostering greater market flexibility.
More generally, labor market policies should attempt to avoid either excessive regulations or extreme disregard for labor conditions. Labor market rules that are very weak or programs that are nonexistent can leave problems of poor information, unequal power, and inadequate risk management untreated, penalizing the poor and the middle class. In contrast, excessively stringent regulations can compound market imperfections with institutional failures, and weigh on job creation and efficiency. Making labor markets more inclusive and creating incentives for lowering informality is a key challenge. Workers often lack equal access to productive job opportunities and do not benefit evenly from economic growth. Many individuals with low skills, in particular, remain trapped in precarious jobs, often in the informal and unregulated economy. In such jobs, even full-time employment tends to be insufficient to lift households out of poverty.
Thus, creating accessible, productive, and rewarding jobs is key to escaping poverty and reducing inequality. Informal workers need to have the necessary legal, financial, and educational means to access formal sector employment. Higher formal sector employment also requires better incentives for firms to become formal. Policies to reduce tax, financial, and regulatory constraints can expand formal sectoral employment by reducing the incentives for firms to operate informally, both by increasing the benefits of participating in the formal sector and by reducing the costs of doing so. Reforms aimed at raising average living standards can also influence the distribution of income. Indeed, tackling inequality goes beyond the remit of labor, social welfare, financial inclusion, and tax policies.
In developing countries, raising agricultural productivity, rapid accumulation of capital, and technology diffusion in labor-intensive sectors can substantially lift growth and ensure that the fruits of prosperity are more broadly shared. Sustaining growth in emerging market economies will require more intensive patterns of growth, greater flexibility to shift resources within and across sectors, and the capacity to apply more knowledge and skill-intensive production techniques. Policies to improve skills for all, to ensure that a nation’s infrastructure meets its needs, and to encourage innovation and technology adoption are thus all essential to driving growth and ensuring a more inclusive prosperity.
(The author is a Research Officer, IIPA, New Delhi. Views are personal.)