May 4, 2018 | 10:00 GMT

14 mins read

Why India's Options to Reduce Inequality Are Limited

In this 2007 photograph, office blocks and residential buildings tower over the notorious slum colony of Dharavi in Mumbai, India.

  • India will have difficulty fostering a larger middle class because the country lacks a suitable base.
  • Because of the shifting nature of the global economy, pursuing manufacturing- or digital-based growth strategies will not make India a high-income country or close its gap in equality.
  • Only more forceful redistribution or civil conflict that destroys capital is likely to even out India's income disparities.

In March, the whole of India tuned in to watch as 35,000 farmers — many barefoot — traipsed across the western state of Maharashtra for six days on the way to Mumbai, India's financial capital, to register their discontent about the hardships so many feel in the subcontinent's countryside. Aware of a nation's eyes upon it, a chastened state administration gave the marchers an obsequious welcome, rapidly caving into demands for financial concessions. Mollified, the marchers dispersed and returned to their farms, as the rest of the country returned to its daily life, awaiting the next conflict.

This vignette — which is common in India, albeit notable for its scale — shines a light on some of the economic tensions that profoundly impact the world's second most populous country. India's economy has developed, but so too has domestic inequality. For all the success stories in Mumbai and Bangalore, half of India's 1.32 billion people struggle to eke out an existence in the countryside. This situation not only has repercussions for the present but will also guide India's future. The economic optimism surrounding India largely revolves around the potential inherent within its giant population, leading investors to salivate at the market that could emerge once India has developed a middle class. It appears, however, that India has little chance of enjoying such a future. The country's development path creates a top-heavy structure that will squander the opportunities created by the country's large population, ultimately dooming India's aspirations of achieving high-income status in the 21st century.

The Big Picture

In its Second-Quarter Forecast for 2018, Stratfor noted that India's government would face mounting challenges stemming from slower economic growth, stagnant job creation and unrest among farmers. Now, in the wake of a massive march by agricultural workers on Mumbai, we look at New Delhi's longer-term prospects for ending the severe income inequality that is hindering the country's growth.

Trailing in East Asia's Wake

For many years, India's inequality figures have concealed the true extent of the country's income disparity. After India gained its independence, administrators began measuring the country's inequality through the National Sample Survey, which gauges caloric consumption rather than income, but this methodology ultimately failed to capture the widening gap between the subsistence farmers at the bottom of the pyramid and the newly minted billionaires at the top. Economists and others subsequently calculated the Gini coefficient, the most commonly used measure of inequality, using the National Sample Survey data to attain figures that painted India as a relatively equitable place. More recent studies, however, have laid bare the extent of its income disparities. Last year, the country scored 51 on the Gini coefficient, meaning only South Africa suffered from more inequality.

The roots of India's inequality stem from its geography, specifically its inability to make the most of its agricultural resources by redistributing land. After World War II, Japan, South Korea, Taiwan and now China all focused heavily on reinvesting export earnings in development. The springboard for these East Asian countries was land reform, according to Joe Studwell, who argues in his book How Asia Works that providing farmers with about 3 hectares of land each unleashes individuals' incentives to produce maximum agricultural yields. Countries can then export such crops for valuable hard foreign currency before plowing the proceeds back into technology. In time, successive waves of exports can propel a country up the value chain as it leaves behind agriculture in favor of low-end manufacturing and, subsequently, high-end manufacturing for products such as automobiles. Not only does this virtuous cycle help pay for the next stage of development, but it also improves the lot of workers, typically distributing wealth among them more equitably.

Bringing Down the Barriers

But India has pursued a different path, largely as a result of its different circumstances. Unlike in the East Asia, India has too many farmers fighting for too little land. The average holding today is 1.15 hectares, while 67 percent of India's farmland is in the hands of farmers who possess less than 1 hectare. Because only small plots of land are available, India has failed to match its Eastern peers in development. Even though it is now the world's largest producer of pulses, it has long trailed other BRICS countries (which are Brazil, Russia, China and South Africa in addition to India) in yields.

A chart shows the top 0.1 percent's share of India's income over time

India's colonial history also discouraged the country's post-independence leaders from pursuing the export-driven model of the East Asian success stories. In the imperial era, Indian business owners became accustomed to an unbalanced economic model in which the United Kingdom exported manufactured goods to India while refusing to allow the latter to raise any tariffs that might protect its fledgling enterprises. Accordingly, when India finally gained sovereignty, administrators reacted against the colonial past by implementing tariffs as a means of nurturing its nascent industries. The barriers sheltered India from external competition, but that protection only served to make Indian industry uncompetitive and dependent on imports to plug gaps that domestic businesses could not fill — in stark contrast to the export-driven models of Japan and South Korea.

But India's overreliance on imports ultimately caused trouble for the country. A balance-of-payments crisis necessitated a bailout from the International Monetary Fund, on the condition that New Delhi liberalize the nation's economy. India's tariff barriers came tumbling down in 1991, but the country did not pursue a development model that had proved so successful for its East Asian peers, because manufacturing remained largely uncompetitive. The new trade and investment freedoms, however, did bolster the services industries, attracting a flood of foreign direct investment to India, which made the country a leader in emerging areas such as information technology services and call centers.

In cultivating an IT industry, some Indian economists argue that the country has successfully skipped a developmental stage by transitioning directly from agriculture to services without first passing through a manufacturing period — unlike Western nations, which emphasized each of the stages at different times in their histories. Two factors, however, detract from the ostensible success of India's services industry. First, the sector does not create as many jobs as agriculture and manufacturing, and second, it only benefits highly skilled workers.

Because India remains a largely rural society and has a literacy rate of just 74 percent, the embrace of the services sector has accelerated the growth of income disparity in the country, creating a sliver of prosperity at the top and a large wedge of poverty below.

A chart shows the contributions of agriculture, manufacturing and services to India's GDP over time

A New Partition

Income disparity has effectively created two Indias. One consists of the modern, shining, urban country showcased by parts of Hyderabad and Bangalore, while the other is the backward, rural Bharat (a name for India that some of today's downtrodden have claimed as a symbol against richer elites) — a country of agrarian unrest, crushing debt and corresponding farmer suicides.

In the first India, hopes are high for the future. Western consultancies and investment banks fire off positive reports about the exciting world that lies ahead for the nation, which appears to be on the cutting edge of the digital world. Multinational investment bank Morgan Stanley believes that internet access will double in the country in the next decade, meaning 915 million Indians will be online by 2025. The government's biometric identity Aadhar system gives most of the population access to online banking services. Global management firm Accenture believes India is well-positioned to take advantage of the coming age of artificial intelligence, claiming it has the third most promising startup ecosystem behind the United States and China. And by the end of this year, students at almost 2,000 Indian schools should have access to labs with robots, 3D printing, additive manufacturing machines and "internet of things" systems.

As bad as it is, the situation in India's agricultural areas could get even worse.

But in rural areas, the contrast could hardly be starker. Farm-related jobs account for 49 percent of all of India's employment. According to the National Sample Survey Office, a farming household requires at least 1 hectare of land to ensure its members' survival, but two-thirds of Indian farmers own less than that. Approximately 52 percent of Indian agricultural households are already indebted, and nearly 70 percent spend more than they earn every month. Over the last two decades, Indian newspapers have repeatedly reported about the increasing numbers of farmers choosing to end their lives, apparently due to spiraling levels of debt.

And as bad as it is, the situation in India's agricultural areas could get even worse. For millennia, the subcontinent's countryside has relied on the annual monsoon for its relative prosperity. Regularity is critical, but the onset of climate change is a harbinger of extreme weather fluctuations that could upend farmers' livelihoods. Irregular weather patterns are likely to hurt drier states, such as the marchers' state of Maharashtra, the most. But even in states with good irrigation, the rising price of water is increasing the suicide rate.

A chart compares the crop yields of India, Brazil, China and the United States

Despite patches of positivity, India's education levels are also weak. School attendance has been increasing, but the quality of learning has not. The 2018 Annual Status of Education Report revealed that just 43 percent of students ages 14 to 18 could perform simple division; more than 40 percent could not read a clock and 46 percent could not name the capital of India, even after eight years of schooling. Another assessment undertaken in 2014 determined that just 34 percent of graduate students were "employable."

The Road Not Taken

It remains unclear whether the situation is salvageable. If the richer India is to rescue its much poorer cousin and offer a more prosperous future for all, one possible method would be to follow the developmental path of the East Asian trailblazers. Such a decision would require India to embrace manufacturing, the great job creator, and gradually move up the value chain, educating its citizens as it goes. The current government has already embarked upon this path with its well-publicized "Make in India" campaign, but organizers have enjoyed scant success so far. New Delhi has highlighted healthy foreign direct investment (FDI) figures as a sign of potential growth, but closer inspection suggests that outsiders are investing in India due to its potential as the next major market, not as a possible export hub. A recent Nomura study presented India as the most exciting FDI destination largely because of the size of its domestic market, but the country has had a checkered history with such investment.

A chart shows the attractiveness of various countries to direct foreign investment

Foreign companies invested heavily in India in the 2000s, but the funds flowed out just as quickly during downturns in the market. Unlike China, India has difficulty retaining investments because they are frequently unsustainable if the market turns, and the subsequent monetary exodus leaves numerous bad loans in its wake. Many tout India's automotive sector, the world's sixth largest, as a national success story, but the country's automobiles are uncompetitive on the global market, serving only the domestic market. 

A chart shows the percentage of automotive production that is exported, by country

India will also struggle to develop through manufacturing because changes in the global economy are shrinking the need for such production. The technological advances of the fourth industrial revolution in automation, additive manufacturing and artificial intelligence will satisfy much of the global demand for low-end manufacturing. In short, robots will construct simple items, leaving the multitudes of low-skilled workers without a role. Even if India were able to improve its internal administration and infrastructure to remove the fetters on its development (the country has made recent strides on this front by eliminating goods and services taxes between states, boosting infrastructure spending and passing a new bankruptcy law to address bad loans), the sector is likely to become less relevant with every passing day.

Because of the risks associated with a manufacturing-led development model, India could instead pursue a development path in line with the spirit of the age by focusing on the internet. India has already laid considerable foundations in the digital sector and employs many in IT. In recent years, the government has made great strides in rolling out the Aadhar biometric identity system to better organize India's giant population, while the much-criticized demonetization experiment of 2016 has resulted in a greater digitization in Indian payments. Accordingly, some are wondering whether the country could soon leave the physical world behind for a better future in a virtual one.

High-end roles necessitate high levels of education.

But here too India appears to have little chance of success. Development largely centers on providing goods and services to wealthier countries in order to extract hard currency, but dishearteningly for India, many IT jobs that foreign companies have previously transferred to India are likely to become automated in the future. As the Western world moves toward embracing AI and automation, humans will migrate to jobs that robots will struggle to penetrate. The key human advantage over the robots will, unsurprisingly, be the human touch. As a result, the best employment opportunities in advanced economies will lie in jobs like elderly care (which will grow in importance as Western populations age) or nannying (as women continue to enter the workforce).

The U.S. Bureau of Labor Statistics has predicted that jobs involving the skills of a nurse, therapist, health-care worker or caregiver will account for more than half of the 30 fastest-growing occupations over the next 10 years. These roles are not easy to perform remotely, making the idea of a giant army of low-skilled Indian caregivers performing their tasks without leaving their hometown — perhaps through some kind of telerobotics as suggested by economist Richard Baldwin — a difficult one to realize. However, the global shift to a more digital and automated world will require coders and engineers to service the machines, perhaps offering the Indian economy an opportunity. But even here, such high-end roles necessitate high levels of education. Such jobs will match the skill set of the Indian elite, but the chances that this line of work will provide an escape for the country's many rural and illiterate poor are close to nil on account of the huge educational investments needed to bring the masses up to speed.

A chart shows the jobs in India that are endangered by automation

Benign vs. Malign Change

Since manufacturing and the internet offer no promise of rewards in the end, where can India turn for succor? The work of inequality specialist Branko Milanovic might provide some relief. Milanovic asserts that high levels of inequality generally return to the mean over time, either due to benign forces, such as widespread education, or malign ones, such as civil conflict that destroys the capital of the wealthy.

A chart shows the forces that reduce inequality according to economist Branko Milanovic

Eventually, forces will emerge to alter the situation and reduce Indian inequality — although they are unlikely to be benign. Peaceful factors spurring change such as widespread education, an aging population and technological developments that favor low-skilled workers do not match the Indian reality. This leaves the possibility of change via redistribution and/or the destruction of capital. Maharashtra's marching farmers have already provided a harbinger of more aggressive potential change. If a political force can emerge that successfully represents the voice of this growing underclass (the Aam Aadmi Party, which emerged in 2012 but has so far failed to make progress outside of New Delhi could be a pioneer of this trend), India could elect a government that is committed to economic redistribution. Such governments tend to hurt growth, which would result in a significant stall in India's progress.

Countless lines of division crisscross India, including caste, religion and cultural north-south differences, all of which could be exacerbated by increasing social distress. If the country fails to address the social tensions induced by income disparity, civil conflict and the destruction of capital could rapidly ensue. In the end, a giant population might have been a boon for India in the 20th century, but it is more likely to be a burden in the 21st.

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