INEQUALITY AND GROWTH
1. Context
Rahul Gandhi’s statements regarding redistribution — and the polarising rebuttal of Prime Minister Narendra Modi — have brought the topic of inequality to the forefront. Researchers from the Paris School of Economics have shown inequality in modern India to be greater than in colonial times.
2. Monopoly Power and Consumption
- Billionaires accumulate their wealth through monopolistic practices. Their businesses hold dominant positions in their respective markets, enabling them to set prices independently rather than allowing market forces to dictate them.
- The degree of price mark-up over production costs is a reflection of their monopolistic power. Consequently, for any given level of nominal wages, real wages—indicating purchasing power—are lower in economies with strong monopolistic influences.
- Currently, these monopoly dynamics are manifesting as cost-of-living crises in developed economies. The term "greedflation" describes companies raising prices to boost profit margins amid various demand-and-supply disruptions caused by the pandemic.
- This practice has been cited as a factor contributing to high inflation rates in Western countries.
- Economic theory indicates that monopolies produce less output than competitive markets, resulting in a welfare loss. Therefore, monopolies can lead to reduced real wages, output, and investment
3. Inequality and Growth
- Imagine a company decides to establish a new factory. Before this new capital asset is completed, wages are paid to workers involved in its construction.
- These workers then spend their income on goods, which boosts the income of the goods-sellers.
- These sellers, in turn, use their increased income to buy more goods, and this cycle continues.
- As a result, the total increase in income for workers and goods-sellers exceeds the initial investment. This phenomenon is known as the ‘multiplier’ effect, where investment increases overall income by more than the initial amount invested.
- However, when companies have significant market power, they can set higher mark-ups and prices.
- This results in lower real wages for workers, who can afford fewer items. Despite selling fewer goods, companies still achieve high profits due to their increased margins. In a monopolistic market, the boost in income from a given investment is less significant because consumers have reduced purchasing power.
- Consequently, investment has a diminished impact on economic growth under monopoly conditions, while company profits remain unaffected.
- One might argue that consumption by the wealthy could stimulate growth. Although the rich consume more in absolute terms, they spend a smaller portion of their income. The multiplier effect relies on the proportion of income spent on consumption.
- In an unequal economy, less income is in the hands of those more likely to spend it, resulting in weaker economic expansion
4.Redistribution and Growth
- Some contend that the "cure" of wealth redistribution might be more damaging than the issue of inequality itself, as it could negatively impact job creation. They argue that high tax rates would reduce entrepreneurs' incentives to accumulate wealth, leading to a decrease in investment and job opportunities.
- It's important to differentiate between wealth and profits. Investment is driven by expectations of future profits, while wealth represents accumulated past profits.
- According to Polish economist Michal Kalecki, taxing wealth does not impact investment since it does not alter future profit expectations.
- For instance, taxing Gautam Adani's wealth would not affect investments in airports, as these are based on the demand for air travel, which is independent of his wealth's value.
- Certainly, making it harder to convert profits into wealth might discourage some business owners from investing.
- However, in an economy with high profit expectations, businesses will continue to invest even if wealth is taxed.
- Redistribution can stimulate growth even if some billionaires reduce their investments. For example, if wealth redistribution increases income, the multiplier effect would strengthen, encouraging businesses to invest where purchasing power is robust. Additionally, reducing monopolies would lower prices and increase real wages, boosting demand.
- Consider Thomas Piketty's proposal to tax billionaire wealth and provide a basic income. While this might cause some to leave the economy, it could also foster a new class of entrepreneurs able to start businesses without needing to work for wages.
- Redistribution is not a cure-all, and excessively high tax rates could harm the economy. However, when combined with other policy measures, reducing inequality can contribute to a healthier economy
5. Way Forward
The relationship between inequality and economic growth is context-dependent. While some inequality may incentivize economic activity, excessive inequality can hinder growth by reducing consumption, limiting access to education and healthcare, and causing social and political instability. Effective policies that balance the need for incentives with the benefits of equitable income distribution are essential for fostering sustainable and inclusive economic growth
Source: The Hindu
