It was unthinkable until recently that any social scientist could achieve the status of a rock star almost overnight. Thomas Piketty, a young French economist, has done just that by redefining the relationship between capital and inequalities in his book Capital in the Twenty-First Century. Piketty’s work has resulted in such a tectonic shift in thinking on the issue that people are now talking about “pre-Piketty” and “post-Piketty” eras.
Piketty’s book is not only very insightful it is also fairly easy to read. Although over 700 pages long, it is difficult to put down once you start reading. Branko Milanovic in his book review in Journal of Economic Literature advises not to take the book on vacation as it will spoil your holiday!
The book is based on extensive analysis of data from Europe and the US so its major empirical conclusions are not directly applicable to Asia and the Pacific. However, the underlying concepts still have relevance for our region. Since I know India better than any other country, I have been thinking of its application to India.
Piketty argues that the market economy, based on ownership of capital and private property, has forces which lead both to a reduction in inequalities (convergence), as well as those that increase inequalities (divergence). The major forces which support convergence are diffusion of knowledge and skills.
On the other hand, the forces that increase inequalities are empirically found to be more powerful. These forces leading to divergence relate to Piketty’s title of "capital”—people who own capital are likely to do better than those who rely only on their labor.
Piketty notes that the rate of return on private capital is usually higher than the rate of growth for income and outputs. As capital ownership is universally found to be unequally distributed, inequalities have grown and will continue to grow. Unless necessary policy actions are taken, entrepreneurs will inevitably become rentiers, and more and more dominant over those who own nothing but their labor.
Unfortunately, this is the trend I have painfully witnessed in India over the years. Consider the following facts:
- The share of labor income in total manufacturing output has been consistently declining from 37% in the mid-1990s to 25% in the mid-2000s, implying that return on capital has been increasing in relative terms.
- The value of real estate, particularly urban land, has increased at an average rate of about 14% in the last decade, benefitting the landed over the landless.
- The interest rate in the informal lending market has been about 18% (10% and above for bank deposits), whereas the average growth rate has been in the range of 5-8%.
- The majority of growth is being driven by the services sector in which only a small proportion of the population is employed (agriculture employs the majority).
- Most, although not all, super-rich in India have their business empires rooted in exploitation of natural resources, rather than through employment generating activities.
- The manufacturing sector, which is critical for generating gainful employment, has done poorly.
This situation is further exacerbated by factors which might otherwise have helped support “convergence”:
- Human capital endowment remains highly unequal with a large proportion of the population unable to read or write. Caste and gender based barriers to education and upward mobility are still deeply rooted in social structures and the quality of education is extremely patchy, making it difficult for a large section of the population to equitably benefit from growth.
- The tax system in India is both inefficient and poorly administered with most rich people declaring only part of their income for tax purposes.
In fact only 43,000 people out of a population of 1.2 billion have declared income of over $170,000 per annum! An efficient tax system, therefore, is a critical element of any effective redistribution effort.
Policies, of course, can accelerate the forces of divergence as well as convergence.
My hope is that the government will aggressively focus on expanding human capital and skills and make its tax system more efficient.
Otherwise, as Piketty says the past will continue to “devour the future.”