What is this thing they call Economic Inequality and how can we beat it?

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The author takes help from a range of experts to get an understanding of why wealth distribution tends to become skewed in economic societies, and how we can begin to mitigate this unfair state of affairs

The creation of wealth is not growth if it adds no benefit to society. | ‘The Wealth of the Nation’ painted by Seymour Fogel

One of the biggest challenges the world faces today is increasing inequality. Oxfam, Credit Suisse and others come out with reports containing shocking statistics — “73% of the wealth generated last year went to the richest 1%, while 67 crore Indians who comprise the poorest half of the population saw 1% increase in their wealth”; “82% of the wealth generated last year went to the richest 1% of the global population, while the 3.7 billion people who make up the poorest half of the world saw no increase in their wealth”.

Conditions of inequality can spell trouble in the real world, as they lead to political and economic instability, both of which the world is experiencing.

The objective of this article is to understand the forces that generate this and to shed light on possible solutions. India, being an emerging market, can perhaps offer some insight into the dynamics at play and perhaps also provide anecdotal solutions for the developed world as well.

Why is this happening?

On the surface, French economist Thomas Piketty is right when he posits that inequality is caused when the returns on capital grow faster than economic growth and the increase in wealth is greater than the increase in income. However, a deeper look reveals other forces at work that allow this. The first concerns the relationship between economics and the way we think, while the second arises out of the institutions we create and the incentive structures that drive them.

 

 

There is an interactive relationship between our thinking and the way economics works. Different commentators have viewed it differently – Performativity (Donal Mackenzie, Michel Callon), Chaotic Systems (Yuval Noah Harari), Reflexivity (Soros). But basically, the idea is that the world is a product of our economics and our thinking.

Free trade is based on a strong belief that individuals will choose the best option available and maximise utility/income. In the bargain, important factors that constrain the best solution from being obtained — such as heterogeneity among people, positions from which the terms of trade are struck, and the distribution of benefits and costs — are often ignored. More importantly, economists also ignore the moral prerequisites laid down by Adam Smith and others for a free market economy.

 

 

This is where Complexity Economics comes to our rescue, giving unparalleled insight into economic phenomena. Interestingly, one of the first studies in this field was the ‘Sugarscape’ study by Epstein and Axtell to understand the way wealth gets distributed in an economic system. They found that wealth inequality was an emergent property — accumulated resources were distributed in an increasingly skewed manner as the whole system grew. The tendency to concentrate could perhaps be seen as a natural feature of human activity. Smith alluded to this way back in his 1776 treatise, The Wealth of Nations.

This leads us to the second dimension of institutions and incentive structures. Our thinking and economics find expression in the institutions we create. The market is an important institution with its own set of incentives, rules, regulations and norms of behaviour which guide transactions and subsequently proliferate into the rest of the economy. While institutions such as markets are universal, their outcomes are heterogeneous and depend on local sociocultural and political arrangements. The degree of concentration is limited or enabled by the institutional settings. It is an outcome of the formal and informal transactions that take place in the market.

In his book Fault Lines, Raghuram Rajan classifies economies into arm’s-length systems and relationship-based systems and describes their dynamics. India continues to be a predominantly relationship-based economy. As resource (monetary and non-monetary) accessibility depends on relationships, rent-seeking behaviour emerges. These outcomes are zero sum as a few gain at the expense of others. Rent-seeking subsequently translates into higher transaction costs and is passed on to others in the economy in the form of higher prices. This behaviour trickles down into the behaviour of other agents.

There was a time in Bangalore city where the autorickshaw-drivers rarely undertook trips that concluded with the customer paying the exact amount reflected on the meter. The fare demanded could range anywhere between an additional — ₹10 to some astronomical figure. This happened at a time when the city was prospering under an IT boom and the auto-drivers felt left out. “While I drive around the city all day, how is it that a kid fresh out of college sitting in an AC office earns more than I do?” the driver laments to his unwitting passengers. Apart from the physical strain, the driver has to pay off cops, the transport department and countless others.

 

 

There is a famous Sanskrit saying: “Yathaa rajaa tathaa prajaa [As the King, so the people]”. Seeing corrupt politicians and bureaucrats engaging in rent-seeking, the auto-driver followed. The people from whom the driver was extracting this rent were commoners like himself.

Anyone who could, did engage in rent-seeking — from bank clerks to ministers. Perhaps this is why there are such large number of wilful defaulters and scams coming to light.

Apart from these, the underlying fundamentals such as demography and the moral fabric of society also pose their own challenges. With a labour force expanding by the millions every year, wages can be kept artificially low.

Solutions

While redistribution is the desired outcome, the method is the issue. Political establishments cannot achieve optimal outcomes as these are a result of compromise between various opposing interests. Thus, a free-market solution is required.

Venture capital is an important social tool for redistribution of wealth. It is important to have a mechanism by which capital flows down in an efficient manner. Venture capital plays a critical role in facilitating this.

These flows must be accompanied by principles at the micro and policy levels. The three principles are: ensuring consumer sovereignty, discouraging rent-seeking, and encouraging entrepreneurship and new business models. (Second and third are inspired by Taleb’s advice)

 

 

Consumer sovereignty is where the consumer is able to determine the goods and services produced. In perfectly competitive markets, consumers can attain absolute sovereignty and minimise exploitation. By raising ‘capabilities’, technology is breaking market imperfections and reducing consumer exploitation, thereby realigning incentive structures.

Discouraging rent-seeking behaviour has two parts to it. The first is of integrating this principle into the cultural fabric of society. This would entail rigorous and long-term measures such as improving the rule of law and reforming the education system.

The second part of discouraging rent-seeking behaviour is destroying traditional business models built on rent-seeking. It is important to disrupt old businesses that corner most of the surplus for only creating place utility or aggregation services. These business models are so common that we fail to recognise their exploitative nature. Disrupting these would empower producers and consumers.

Consider the case of the Indian agriculture market. The farmers earn a fraction of the retail price that is paid. The middlemen earn a high premium simply for aggregating and creating place utility. Mallika Mango farmers in Srinivasapur (a town 100 km away from Bangalore) are asking for a support price of ₹7.5/kg while the consumer in Bangalore pays over ₹80/kg.

 

 

This brings us to the third point of new business models. Entrepreneurship and new business should focus on democratising capitalism as this increases earning capabilities. A transition should be encouraged from models where the middlemen/aggregators corner the surplus to one where fee/commission models are based on marginal cost. This will increase returns to labour while also ensuring increasing returns to capital.

Let us consider the case of Uber and its Indian competitor, Ola. Perhaps the largest redistribution of wealth in the country in recent times has been facilitated by these two. The emergence of opportunities for self-employment has attracted people from rural areas with large families. Cab-drivers who worked for a paltry salary of ₹10,000 or ₹15,000 a month, now earn over ₹60,000. The ecosystem also benefits as rent-seeking behaviour elsewhere (autorickshaws) is also eliminated by competition.

Trickle-down economics, where money trickles down from the top of the society to the bottom, is another infamous if Utopian solution. Perhaps the context or institutional arrangements within which this was conceived limited its possibilities.

Trickle-down by way of investing in start-ups and future-oriented ideas is a powerful solution. Encouraging capital flows to new ideas also encourages redistributive flows. This would also require consumer sovereignty to come through in the form of access to funds and resources. This will increase the number of firms as well the competition.

The flows are redistributive in nature as they reallocate resources from the rich as well as pseudo entrepreneurs, to the producers. Investors may make enough money on successful ventures to cover the losses of failed ventures (which are also redistributive). Thus, this is market-friendly.

It isn’t the end result of concentration that is the problem but rather the consequences of the manner in which concentration is happening that is the problem. Channels that facilitate flow of money from the top to the bottom play a critical role. Rent-seeking must be discouraged while improving consumer sovereignty.

(The author would like to thank Aviral Bhatnagar for his inputs)

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