Thomas Piketty has kicked up a storm with his rather well-researched view on the pitfalls of capitalism as is practised in the West. While he does not quite predict doomsday like Karl Marx did over a century ago, he shows that inequalities have widened in western society and that this could be the downfall for the system as low growth and high capital accumulation would have no room for consumption. He prescribes progressive taxation as a solution. Where would India stand in this context?
India may be described as a semi-capitalist economy where private wealth has been allowed to grow freely, while the government remains important with combined central and state government expenditure accounting for a third of GDP. With economic reforms coming in, a thrust was provided to the private sector with substantial liberalisation for both domestic and foreign investment and easing of trade restrictions. While critics have called it crony capitalism, others have argued that the rich have benefited more than the poor. What is the true picture, if such a story can be discerned?
Piketty?s tenets can be examined in the Indian context. Inequality exists in terms of both wealth and income with a strong relation between the two. Forbes lists the top 100 wealthiest Indians, who are from industry, being valued at $300 billion. Given that our GDP is a little less than $2 trillion, this ratio comes to around 15%, which is high. Piketty?s argument is that most of this wealth is of the nature of ?rent? as it has been inherited and not earned.
In terms of income, the picture is ambivalent. The Ginni coefficient for consumption in India over the last 30 years shows a mixed picture. Based on data provided by the Planning Commission, the coefficient remained virtually unchanged in rural regions but increased in urban areas. It was at 0.28 in 1973-74 and 2009-10 in rural India indicating that economic stratification is less prominent and that the government?s social and economic programmes including MGNREGA have been equalising forces.
In urban India, there has been an increase from 0.30 to 0.37 indicating widening inequality. Intuitively, one can see that large-scale migration to urban areas and skewed incomes in this segment has furthered inequalities here. In corporate India, the inequalities are stark and Piketty would argue that corporate managements have tended to legitimately pay themselves higher remuneration that includes compensation through remuneration and stock options which is not equal down the line. Also, the compensation structures are different across the private and public sectors. Interestingly, the share of wages and salaries to sales for the corporate sector has remained virtually unchanged over the years.
But the Ginni coefficient in India in relative terms across other emerging markets is much lower as per World Bank data. In 2009, the coefficient was 0.42 in China, 0.55 in Brazil, 0.40 in Russia and 0.63 in South Africa, while it was 0.34 in India (2010). There is, hence, some comfort to be had here that India does better on a relative scale.
Piketty has the view that a warning signal is given by the relationship between return on capital and rate of growth in income. If the former grows faster than the latter, then there is a problem. This becomes serious when growth in GDP plateaus once a high level is reached. With our potential GDP growth level not yet being attained and maintained, there is still surplus space left for growth. Further, return on capital when adjusted for inflation would be around 6-8% both in terms of corporate performance over the years and stock market refunds which average between 14-18%. However, when the industrial sector and economy slow down, the return on both equities and corporate financials also decreases, thus not resembling the Piketty inequality equation.
What are his solutions? He talks of a progressive tax structure on income and wealth so that the rich pay more tax, which can be used for redistribution. Now, in India, we do have a progressive tax scale for income and a tax on wealth. But the entire approach is tilted towards the rich. The long-term capital gains tax is nil, which benefits the rich, and is questionable. The rationale is that more secondary market activity helps the primary market to blossom, which leads to capital formation. But we have not seen a lot of equity being raised and it is invariably the higher net worth individuals, investment banks and brokers who benefit from such moves when gains are made on the market. Piketty is critical of such tax systems that favour the rich without bringing any value on the table.
While the government has made an attempt to tax the super-rich and the DTC would try and get in some more tax revenue, the fact is that there are lots of exemptions and arbitrage opportunities provided to pay low tax. The case of using Mauritius as a tax haven is a good example of taking advantage of tax arbitrage by operating in the market by FIIs. Thus, all systems gearing towards capitalism would invariably work towards self-rewarding.
Also, the prevalent mindset is pro-capitalist where the myriad benefits provided to corporates through tax breaks (valued at over R5 lakh crore in FY13 as revenue foregone by the central government) is defended vehemently while expenditures on fuel and food subsidy and the MGNREGA programme valued at around R2 lakh crore is often critically debated. Therefore, the intelligentsia is also tuned towards supporting the rich.
If the Indian story does display some resemblance of capitalist tendencies, are there chances of a future crisis? Prima facie, it looks unlikely because of two reasons. One, India has still not reached a stagnant rate of growth and there is plenty of spare capacity. Two, there is a growing bourgeois class that acts as a buffer and reassures the poor that mobility is possible and hence there is hope. This ensures there is still a large market for products and consumerism. The government nonetheless needs to embark on a growth doctrine which takes along the poor to ensure that the chasm does not widen between the rich and poor.
The author is chief economist, CARE Ratings. Views are personal
