Growing inequality

The self-employed as a group, despite growing as a proportion of the employed, has seen a fall in its income share in the five-year period from 2000. Here, a couple who sell vegetables in Hyderabad.-D. GOPALAKRISHNAN

The recent investment boom has been a profit-led one in which the private corporate sector is the greatest beneficiary and also the greatest contributor.

SINCE the turn of the century, the Indian economy has been widely perceived to be on a rapid growth trajectory that is significantly faster than that of the previous decade. Certainly, the National Accounts Statistics show that in the period since 1999-2000, real gross domestic product (GDP) has increased at an average annual rate of nearly 8 per cent.

This higher growth is clearly driven by higher investment, since investment rates in the economy also appear to have gone up in this period. But what exactly has caused this shift to what appears to be a higher growth trajectory? In particular, why have investment rates increased? Is this the cause or the result of higher growth? And what implications does the answer have for the nature of the economic growth process itself?

To consider these issues, it is necessary to examine first of all the recent trends in investment and savings rates. But then it emerges that since 1999-2000, savings and investment rates have not been consistently on a clear upward trend. Indeed, until 2002, they fluctuated around levels broadly similar to those of most of the 1990s, between 24 and 26 per cent. Only from 2002 savings and investment rates showed a clear tendency to rise rapidly.

But it is true that the increase over the past four years has been remarkable, with investment rates apparently reaching around 34 per cent of GDP similar to the levels in several of the fast-growing East-Asian economies during their period of economic boom.

What is also significant is that even in this phase of higher growth, for several years domestic savings rates were higher than domestic investment rates, indicating excess savings that were not finding adequate outlets for investment within the economy.

Clearly, the bullish spirits of entrepreneurs were not so strong as to lead to even higher investment rates that were easily feasible given the rising domestic savings. It is only in the very recent past that domestic investment has been higher than domestic savings.

So what explains the increase in domestic savings? In the 1990s, the moderate rise in savings rates was led by household savings in physical assets. Since the turn of the decade, the increase in savings rates has been driven by a reduction in the net dissaving of the government (even excluding public sector enterprises) and significant increases in private corporate savings as percentage of GDP.

This very large increase in private corporate savings a doubling of the rate from 4 to 8 per cent in just five years reflects the dramatic increase in profitability over this same period. It reinforces the perception that the private corporate sector has been the chief beneficiary of the economic boom.

Meanwhile, household savings in physical assets has actually been declining as a share of GDP in the recent past. This covers not only house construction and other building up of physical assets by households, but also real investment in agriculture as well as by the non-agricultural small-scale sector, which is not part of the private corporate sector. So this measure of savings is a proxy for investment by the majority of small enterprises, which also happen to employ the bulk of the work force in the country. Since a real estate and construction boom occurred over the same period, the decline is unlikely to have been in this area. Rather, this suggests that real investment by agriculturalists and small enterprises has come down as a share of GDP, despite the apparent macroeconomic boom.

It is often argued even by important policymakers and government leaders that external capital is essential to allow the Indian economy to grow, and that, therefore, it is critical to undertake various measures to encourage more foreign direct investment (FDI) and more portfolio investment. Yet net capital flows have been negative for a significant part of the recent period of high aggregate growth. Indeed, they were negative and falling when domestic investment rates were increasing quite sharply.

Even when net capital inflows have turned positive, as in the very recent past, they still form a negligible proportion of the investment and certainly a minuscule proportion of GDP, at only 1.3 per cent at the peak in 2005-06. They cannot be said to have added significantly to domestic savings such as to ensure higher investment rates, since their contribution has been either negative or marginal.

Similar trends are evident when the components of investment are examined. Investment by households (which includes, as mentioned above, all non-corporate investment in agriculture as well as investment by non-corporate small units in industry and services) used to be the major component of gross domestic investment. It increased in proportion of GDP between 1999 and 2002, but declined subsequently.

In fact, in 2005-06 it was overtaken in importance by investment of the private corporate sector, which increased very sharply from the same period. Meanwhile, public sector investment has remained broadly stable as a proportion of GDP.

What all this suggests is that the recent boom has been driven by the private corporate sectors increasing role in both domestic savings and investment. And this in turn has been driven by an increase in corporate profitability, which has been especially marked since 2002.

Even national income data show this increase in profits. The share of operating surplus of companies, which includes both private and public enterprises, increased from around 12 per cent of GDP at the start of the decade to nearly 16 per cent in 2004-05, which is a remarkable increase of around 30 per cent in only five years. At the same time, the share of employees compensation came down marginally. This included both workers wages, which came down quite sharply, and remuneration of salaried employees, which went up.

The increase in corporate profitability in turn is not a sui generis phenomenon, arising simply out of the growth process itself. Rather, it is the outcome of government policies. It can be explained by the combination of the low interest rates and numerous tax concessions and implicit subsidies that have significantly increased retained profits over this period.

Meanwhile, the category mixed income shows a declining trend in income share, and over the same five-year-period its share fell by around 8 per cent. This is significant because this includes all the self-employed, who have been growing as a proportion of the employed and who now account for half the work force in India, according to the latest NSS large survey. So, even while the share of population dependent upon mixed income has increased, the share of income received by this group has fallen.

So this is a profit-led boom, driven by increasing inequality not only between workers and capitalists, but also between different categories of producers. The private corporate sector is the greatest beneficiary and now also the greatest contributor to the boom. But the non-corporate producers and small and tiny establishments, as well as petty self-employed producers of goods and services, are clearly not gaining in relative terms, and in some cases may be worse off absolutely.

This allows us to relate the macro-economic and national accounts data to the evidence from the employment surveys, of falling shares and worsening conditions of wage employment over this period. It also allows us to understand why the theme of two Indias is unfortunately so persistent and so plausible, at least in economic terms.