Inequality of income or wealth is not inevitable. Several studies explain what causes it and also how it can be reversed. Two examples are particularly instructive for India in reversing it: Scandinavia and Latin America. Scandinavian societies are highly egalitarian, have high living standards and are also the happiest in the world (ranking top 1 to 4 and 7 in the World Happiness Report 2024). In contrast, the Latin American experience was short-lived.
Those worlds were vastly different from each other and decades apart, but provide good general lessons for India as its inequalities in both income and wealth reach “the highest historical levels” in the past decade – and threaten its future growth.
What Scandinavia did right
The Scandian/Nordic countries – Sweden, Norway, Finland, Denmark and Iceland – began their egalitarian journey in 1930s, after the devastating World War I.
But before looking at how they did it, it is important to keep four facts in mind: (i) the change happened within the free-market capitalism framework (ii) continued during both growth and recession periods (iii) despite governments of different ideologies taking office and (iv) were not rich when they started.
These facts preclude two big no-nos in today’s India: (a) India need not go back to the Nehruvian socialism which evokes strong resentment – although that was when India actually reversed both income and wealth inequalities and (b) India does not need to wait to be the third largest economy to attempt it.
When Scandinavians began their march, their unemployment level was very high and so were social and industrial conflicts. The change was “pioneered” by broad-based popular social movements – fighting poverty, building state institutions for social and economic growth and political democracy without violence (unlike the Marxist experiments in the Soviet Russia). It helped that they were democracies; had shared history and societal developments and they were small economies with a high share of primary sectors.
The key elements of the change were:
· Wages were renegotiated to bring (i) low wage increments for high-productive sectors (which reduced cost, shifted investments towards technological advancement and productivity) but (ii) relatively high wages for low-skill sectors (reducing wage inequalities and gap between rich and poor).
· Institutional and universal healthcare, education, social security and other social services (“cradle-to-grave”) – through both direct transfers and public investment in capacity building.
· Progressive and effective taxation – as against India’s tax system marked by high indirect tax and low direct tax.
· “Open economies” – “protection without protectionism” for workers (no protectionism in international trade, for example).
· Welfarism was directed at raising labour participation (they have very high LFPR and FLFP), which brought higher productivity and greater political support.
These changes were sustained over a period of time and has endured – although latest studies show income inequality is rising again (the Great Recession of 2007-09 and European debt crisis impacting their redistributive policies, among others). But when the pandemic hit in 2020, they managed it with least disruptions to healthcare and economy – way better than the US, their European neighbours, and India. The world came to appreciate them even before that but more about it later.
Latin America falters
Latin America – comprising of 18 countries, Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Uruguay, and Venezuela – reversed inequality during the first decade of this millennia (2002-2012/14). That was a time when the rest of world was witnessing high and rising inequalities. It is now back to being one of the most unequal, with a large informal sector and high dependence on agriculture for jobs – very much like India.
Their decade (2002-2012/14) saw high GDP growth and high improvement in social indicators. There is “no consensus” on the exact causes in various studies (given the diverse set of countries and policy variables) but the major contributing factors have been identified as “structural reforms and increased social spending, a decline in skill premia, and strong macroeconomic policies”.
These factors included well-designed social and economic policies: High spending on higher education and skilling (increasing skilled labour supply), higher tax revenues from direct and property taxes – tax revenue averaged 20% of the LA’s GDP while it was 34% for OECD and India’s 10% in 2012 – conditional cash transfers linked to better educational outcomes among poor (specially in Brazil, Mexico and Chile; recall Brazil’s Bolsa Familia) and higher wages (for example, minimum wages in Brazil increased by 70% during 1997-2009).
There were external factors too – stronger FDI inflows and international trade (common to emerging economies like India at the time).
But why did it fail?
In sharp contrast to the Scandinavian countries, there were several factors at play – both internal and external.
The redistributive policies didn’t lead to higher labour market participation (apparently not designed to) and was hampered by mismanagement, corruption, rise in interest rates, lack of support from elites (later leading to a right-ward shift in politics). After the burst of FDI inflows and commodity exports in this decade, they weakened – as it happened for all emerging economies, including India, as the Great Recession of 2007-09 hit). This weakened growth and capacity to sustain the change.
Unlike the Scandinavians, the Latin Americans had weak democracies to begin with (“persistence of weak states in most countries”) – which meant “limited capacity” to implement systems that sustain redistributive policies. It also meant the support to private businesses weakened – and along with the non-universal nature of social welfare policies led to weakened elite support to the change.
Factors that cause inequality
More factors causing inequality were identified after the Great Recession of 2007-09 – which are equally important.
One such study of 2015 looked at the growing inequality in the UK that followed its privatisation drive in 1970s (Thatcherism) and pointed to two significant factors: (a) (neoliberal) small state and (b) privatisation of public assets weakened the state capacity to manage inequality (Piketty and Chancel too argue this, particularly in the Indian (PSUs) context). This wasn’t a “fashionable position among economists” at the time, the study said, and claimed that the sources of inequality were in both capital and labour markets and government policies. It also flagged (c) worsening social conditions (crime and ill-health) due to the “highly unequal nature” of societal ties – like India’s discriminatory and exploitative caste system which Acemoglu and Robinson (“Why Nations Fail: The Origins of Power, Prosperity, and Poverty”, 2012) identified as the big factor for India historically not developing despite its rich civilisational and trading histories.
The World Bank-IMF also turned their focus on income inequality in the post-Great Recession phase.
One IMF study of 2015 found trade globalisation (wakening labour-intensive sectors), weakened workers’ rights (temporary and contract workers, trade unions and collective bargaining power disappearing) and regressive taxation (massive corporate tax cuts) and ineffective social transfers causing income inequality.
It was around this time that the IMF – which pushed neoliberalism in 1980s with the World Bank (small state, fiscal austerity, privatisation of public assets, lower corporate tax etc.) causing a sharp rise in income inequality – sought to validate the Scandinavian model of welfare-states.
In an article in its magazine of December 2018 (“Shifting Tides”), it ran an unusual strapline: “Dramatic social changes mean the welfare state is more necessary than ever.” It recognised that the world has changed for worse and justified “welfare state”. There were two important statements: (a) “…Scandinavian countries vote for higher taxes to finance more and better public services in a way that is politically not possible in the United Kingdom or the United States” and (b) “…systems that work well are based on social insurance or tax financing, not private actuarial insurance”. In effect, it negated the push for small state and private sector-driven social wellbeing of people.
Another IMF study of 2020 blamed it on growing financialisation – disproportionate rise of financial sector vis-à-vis real sectors of economy (which explains stock market booms across the world months after the pandemic hit in 2020). It examined 200 countries over a period of 1993-2017 to find income inequality increasing before a financial crisis, falling during it and rising again after the crisis as lower-income households disproportionately experience income loss.
The pandemic added to the literature.
A global study of 2022 by the Oxfam-DFI (“The Commitment to Reducing Inequality (CRI) Index 2022”) looked at the pandemic responses and the rise in inequality.
It concluded that “most of the world’s governments failed to take major concrete steps to mitigate this dangerous rise in inequality”. It ranked India lowly at 123 among 161 countries, and flagged its policy deficits: (a) “no minimum wage” and limited social security (b) “dismantled” labour rights through “new repressive laws” in 2020 and (c) “among the lowest performers on health spending “again”. It did give high marks in tax policies then, but now we know how the tax system has become even more regressive (GST touching new peaks and corporate tax falling behind income tax in three fiscals and heading for fourth.
Many Indian studies have also identified the inequality drivers for India.
In 2007, one study listed a few: Fiscal tightening (expenditure cuts on state capacity); regressive taxes (more indirect, less direct taxes); financial sector reform that reduced institutional credit flow to small producers and agriculturalists and liberalisation of trade and FDI leading to more regional imbalances and adverse impact on livelihoods and employment. In 2015, another study added to the list: Leaving redistribution to market, leading to erosion of the state as an instrument of ‘inclusion’ and crony capitalism. In 2018, yet another study added: Stagnated wages and reduced wage shares; lack of social security for workers; weakened trade unions and collective bargain; poor land reforms; subsidies for rich corporates (tax cut, NPA write-offs etc.) and supply-side emphasis pushing capital-intensive industry.
To sum up, both factors that cause inequality and reverse it are known. It is for Indian policymakers and planners to take it from there and design India-specific policies for a course correction.
