Avinash M Tripathi

Democracy is often seen as an egalitarian system, not only formally—each person gets a single vote irrespective of her class and wealth—but also substantively. The argument is that the frequency of elections and the need of political leaders to get elected incentivise redistributive politics. Parliamentary election currently underway in India is a testament to this wisdom. A number of distributive ideas—cash transfers, loan waivers, reservations in public employment to the economically weaker sections—have been bandied about. Irrespective of the actual outcome, all parties seem committed to some form of redistribution, at least in rhetoric.

While the reduction in inequality is a good thing, the flip side of the emphasis on distributive politics is its adverse impact on growth and development. This view has been most clearly expressed by Arthur Okun in his book Equality and Efficiency: The big trade-off. Okun’s logic is straightforward. Arguably, distributive transfers need to be financed by higher public taxation. Higher tax rates, in turn, reduce incentives for work and innovation and affects savings, investment and capital formation.

Even more problematic is the fact that electoral transfers are, in practice, not the most efficient way of reducing inequality. This is so because such transfers, though advertised as being targeted at the bottom of the income distribution, are in reality targeted at the politically dominant interest groups. As Aaron Director was the first economist to point this out, this empirical finding is often called Director’s law.

In other words, good politics does not translate into good economics. There is a sharp conflict between increasing the size of the economic pie and ensuring a fair division thereof. Hence the title of Okun’s book: The big tradeoff.

Okun and Director’s view of the relationship between elections, inequality and growth is not without empirical basis. For example, it has been found that taxes as a proportion of GDP are much higher in democracies compared to non-democratic economies.

The trouble with their view, however, is that it overlooks the role of both the policy and political persuasion. The form of redistribution—both on the taxation and spending side—matters as much as its magnitude. Some taxes—think of a tax on entrepreneurship or entry taxes—are more distortionary than others. Some forms of spending—think of public spending on education and health—are more conducive to long-term growth and welfare than others.

Economist Roland Benabou has argued that financing education by a progressive income tax schedule does distort labour supply and saving decisions. However, it mitigates problems inherent in ‘missing’ credit and insurance markets which limit investment in schooling and human capital.

Consequently, there is no trade-off between equality and growth. A tax-funded education financing programme can achieve both, at least up to a certain point.

This finding is particularly relevant for developing countries, such as India, which suffers enormously from such ‘missing’ market problems. In short, redistribution by providing ‘merit goods’ may alleviate the sharp conflict between growth and equality which bothered Okun.

Finally, it has been contented by economists of different ideological persuasions, such as Raghuram Rajan and Joseph Stiglitz, that high level of inequality makes the growth process unsustainable and volatile, possibly by spurring the demand for the ‘wrong kind’ of redistribution. Rajan, for example, has argued that in the United States, the financial institutions were forced to lend to subprime borrowers as a kind of palliative for the structural inequality, which in turn, led to the global financial crisis.

Examples galore where the redistributive conflict generated by structural factors and wrong policy choices led a country into the middle-income trap. A research paper published by the International Monetary Fund found that the risk that the growth spell would end does depend on the degree of redistributive conflict in the economy.

In theory, it is the job of the politician to ‘sell’ their voters the ‘right’ kind of redistribution; at the same time, resisting the temptation for the ‘wrong’ kind of redistribution. By articulating a case for right policies in the popular idioms, politicians are expected to act as a mediator between the policy wonks and the public at large.

However, as Oscar Wilde has said, it is easy to resist everything except temptation. If ideas which balance the needs of equality and growth do not attract the attention of politicians, it is not because they are impossible to find, but mostly because politicians are driven by the short term ‘self-interest’ rather than the long term ‘enlightened self-interest’.