In this essay, the author looks at the dynamics of development in an ever-changing global context. The global context here is the proliferation of global capital flows, which has led to increased economic integration among nations, indirectly resulting in increased inequality across nations, across social groups, and among individuals. While keeping in mind that correlation does not imply causation, the author recognizes the fact that the free market is not the only factor that has aided inequality. Within this understanding of rising inequality, the author addresses the need for government intervention in correcting market failures, by drawing heavily on existing literature on development and public economics. The author traces existing literature on the relationship between inequality and capital income while showing how an increase in the skill premium is also related to higher levels of inequality. Finally, the article outlines a few niche areas which require active policy interventions to better direct the flow of capital in order to aid long-term and sustained development practices.
Development is both complex and nuanced. Over the years, the definitions have changed, and there has been no single deterministic path to its understanding. Development and the “politics of development” are two inseparable components. What it entails and what it does not, cannot simply be put in binaries, and the normative discourses around such issues keep evolving over time. Today, the discipline of Economics has evolved from a positivist perspective of “what is” to a more normative understanding of “what it should be”. However, the victory of the neo-liberal order has compromised the efficacy of basic interventionist non-tangible investments such as healthcare and education and has largely synced growth with the free market. This appeal of the free market has indeed created winners but also exacerbated the losses of the losers. The rationale was to compensate the losers via the surplus gains of the winners through effective economic redistribution. However, market economies today are wary about spending, as debt levels are rising, complemented by larger fiscal deficits. The debate in Economics is still polarised when it comes to fiscal spending. For instance, Buchanan was of the view that higher fiscal deficits are not necessarily a bad thing if such fiscal spending can sustain growth.
There exists a fine line between redistributive policies and free market structures which needs to be respected and understood. Anything that breaks this balance can set off a chain of economic and political disasters that can create large-scale inequality all across the planet.
Disillusionment with the Free Market
The idea that the free market aids better growth through physical infrastructure growth is quite possibly a misnomer. This glorification of laissez-faire economics has come at a cost, a cost that has systematically made the rich richer and the poor poorer, aiding an order that legitimizes neo-colonialism (Ritzer, 1993). John Perkins in his book, “Confessions of an Economic Hitman” talks about how the neo-liberal economic agents often work as “hitmen” to smaller, developing countries, sanctioning huge infrastructural loans when they are clearly less risk averse. Infrastructure spending and IMF loans are all part of the trickle-down package of the Washington Consensus that has created debt-laden regimes all around the world (Rodrik, 2013). Such exorbitant lending, put at the disposal of private independent agents and firms, is used up in sectors such as construction, dams, and railways among other infrastructure sectors, where the risks of corruption are higher. And the incentives attached to corruption are often the reasons why poorer developing countries are attracted to such large infrastructural loans. The underlying idea is, when corruption and secrecy complement each other, it entails huge social costs. The demands of such secrecy shift investments away from critical areas such as education and health, to areas such as defense and infrastructure, which are not really the priority sectors in a poor country. (Shleifer and Vishny 1993).
The Need for Redistribution
Beyond its consequential politicization, economists have long supported the need for substantial welfare and redistributive measures. One of the best-known scholars on redistributive economics is undoubtedly Joseph Stiglitz, who sees the transition from a less developed to a developed economy through the lens of robust government intervention. He states three stages. The first stage deals with a poorer economy, one that requires the most significant public intervention: the need for a sizable public sector is imminent here. The theory of the “first best”, which envisions market-based Pareto efficiency, has its own loopholes in the form of externalities, inadvertently leading to inefficiencies.
Here comes the need for “the second best”, which calls for government interventions to correct these inefficiencies. A similar rationale for government intervention as a base for Industrial Policy is given by Nicholas Kaldor who talked about how faster manufacturing sector growth propels the rest of the economy following Verdoon’s Law of positive externalities. The Feldman Model of Soviet Russia, The Nehru-Mahalonobis Model in India, and Krugman’s hypothesis (1995) of Locational Agglomeration are all supplemented by the need for an interventionist industrial framework, especially for developing countries. The other reason why public welfare becomes so essential can be perceived through Thomas Piketty’s arguments, which have revolutionized economic thinking in the 21st century. Piketty suggested that economies today function on the underlying idea that the rate of interest (r) is greater than the rate of growth (g), which according to him is primarily the reason for greater inequality in contemporary times (Piketty, 2014). Imagine a person A with an annual income of one thousand dollars per annum, with no generational or underlying wealth. Imagine another person, B, with the same income, who also has a stock of generational wealth of, say, two thousand dollars. While the Gini Coefficient for consumption inequality is always lower than that for income inequality (the gap is much higher in the case of India), both A and B will spend a similar amount in terms of daily spending needs (Krueger and Perri, 2006).
Now for B, it is understood that they can earn interest on the two thousand dollars of generational wealth, year after year. But there is no growing capital accumulation for person A. This is where the cycle of capital accumulation worsens for A, as consumption takes away a considerable share of their income every year. It is clear how the “g” here, the growth rate of income, is less than the “r”, the rate of interest. It is in similar terms that the growth rates of economies have been on the decline while interest rates are on the rise. Especially in contemporary times, when inflation has peaked in major economies, the problem of rising interest rates has made many suffer, especially the ones at the bottom of the income hierarchy.
A clear pattern of higher inequality arises from such considerations, especially in countries where sizable reductions in capital income are seen. Inequality rises when the tax on capital income (corporate tax et al) decreases. The US saw similar patterns of increased inequality post the Reaganite policies (which focused on lower capital income tax, deregulations, etc) of the 1980s and it has been on an upward trend ever since. The graph below shows lower levels of inequality between the 1930s and the 1980s, a time when top tax rates were high on high-income individuals, along with relatively higher corporate tax rates.
Similar patterns emerge in India, especially post the 1990s when the economic reforms exaggerated inequality in record levels (Kar and Sakthivel, 2007)
Spending Cuts, Austerity et al
When it comes to undermining welfare and strengthening austerity, be it through spending cuts, interest rate hikes, corporate tax cuts, and in general, the decimation of unions, welfare cuts et al, austerity has become a potent fiscal weapon of the state to preserve the capital order (Mattei, 2022). Austerity as a fiscal measure was a product of the crisis of capitalism after World War 1, which eventually led to the Great Depression of 1929. Keynes in 1919 stated that the collapse of the economy was a significant concern not just for the workers but also for the bourgeoisie, and the capitalist order in general. This was when austerity was born, to prevent the collapse of the capitalist order and to maintain the status quo of economic power relations. This new regime, masquerading as a democratic framework, expels the worker and their power as the real driver of the economy, crushes union power, and justifies corporate taxes and the role of the capitalist, the entrepreneur as the real driver of the economy. Empirically, austerity has never really achieved its goals of reducing the debt burden and achieving fiscal constraints.
The important context to keep in mind is that the poor, being heavily dependent on primary and informal sector jobs, do not possess any form of social security protection. They largely depend on public services which again, depends on a welfare model that might put a dent in state finances. The forces of globalization require that there must be cuts in budgets for public services, essentially as part of the fiscal and macro-stabilization packages of the IMF and the World Bank.Bardhan(2006) argues that such a rise in fiscal deficits for developing countries has often been brought about in the first place by subsidies to corporates, increased defense spending, and public sector management salaries among others. Hence, the fiscal packages for priority sectors such as public health and education are often limited in these countries. For instance, India’s education sector investment is around 2.9% today, while the envisaged share was 6%, that too, back in the 1960s.
Political Participation, Demands for Larger Social Support
In times such as these, when the free market has clearly not trickled down income and capital to the bottom, there is an utmost need to realign discourse on public spending. Firstly, there needs to be a consensus that free-market is worth it as long as it makes the pie larger, such that the income gains of the winners must be greater than the losses of the losers, followed by a progressive redistribution of these gains. Secondly, the positive links between economic growth through integration and poverty alleviation must be explored. There are policies that can aid the poor and alleviate poverty without undermining the forces of the free market. Thirdly, policymaking cannot function in isolation, away from political intuitions and institutions alike. Proper assignment and correction of property rights, reforms in regulatory frameworks, labor market reforms, raising farmers’ income in developing countries through increased market access for producers, progressive taxation regimes, etc are some of the most basic ways to ensure collective human development. In terms of higher human development achievements, Sen exemplifies states such as Kerala, Himachal Pradesh, and Tamil Nadu, and broadly emphasizes on three reasons: a) a larger social support base b) expansion of human capabilities, and c) participatory development. While the three of these are equally disruptive, the concept of participatory development is probably the most radical. It focuses on the need for political participation, democratic social movements, and constitutional demands that have institutionalized growth and development in better-performing states. There is a need to rally behind social movements that ask for economic accountability, the right to access basic public goods, and the right to economic security. As long as such demands are not pressed hard enough, welfare will see its end and development will be skewed towards the rich.
About the Contributor
Aaswash Mahanta is a researcher at IMPRI and an undergraduate student pursuing Economics Honours from Shaheed Bhagat Singh College, University of Delhi.
Read more by the author: Rethinking Sustainability through Environmental Social Governance (ESG)