Income disparity and unclogging the pipes

Economic disparity is heartbreaking, seeing some people buy multi-crore apartments while others have to skip meals or beg on the road.

But it turns out things are more nuanced than this: when one buys products and services, the money goes to poorer people, like taxi drivers, waiters or factory workers. And when the taxi driver buys himself a shirt, the money flows to the textile workers. Money flows through the economy from richer to poorer people.

If instead of spending all of one’s income, one invests it, that also helps poorer people. For example, if one builds a house [1], some of the money goes to laborers, painters, electricians, plumbers and so on. If the owner then rents it out, rather than keeping it vacant, it provides sorely needed shelter to people. If someone invests in a mutual fund or bank account or FD, the money is used to lend to companies to grow, which helps the economy, if only by reducing the cost of capital.

If this system were working perfectly, it wouldn’t matter where the money started: if a person earns a crore a month, but the money flows [2] to the rest of us, that’s perfectly fine. Imagine three connected water tanks:

It doesn’t matter which tank you pump water into, since it redistributes itself. The economy should ideally work this way. But when the pipes are clogged, it’s the poor who suffer. The tank that was dry remains dry.

An example of clogged pipes is bad labor laws. I read that there’s not one minimum wage in India, or even one per state or city, but tons even within. For example, a lorry driver has a different minimum wage from a lorry cleaner. Companies need permission from the government to fire employees. And so on. Companies in India are therefore more capital-intensive, as opposed to labor-intensive. This doesn’t make sense in a country where salaries are low.

Ideally, there should be no minimum wage at all. Is it better for someone who earns a low wage to not have a job at all, and be replaced by a machine? Or by a worker in another country? In a globalised world, every country has to be competitive — we can’t choose not to be because we have all these ideas that seem right in an abstract moral sense. If the government feels every worker should earn a minimum wage, it should be up to it to either pay them the difference with what they actually earn, or train them so that they can seek higher-paying jobs. Not push the costs onto companies, who then won’t hire as much.

Likewise, companies should be able to fire people without advance notice, or with at most a month or two of notice. They should under no circumstance need government permission, which is a horrible throwback to the bad old socialist days when you had to ask permission to manufacture 1000 scooters and then to sell them at a particular price. Companies in India don’t hire, because they can’t fire [4]. Surely that doesn’t help jobseekers, does it?

Beyond that, the government should eliminate other barriers that block the flow of money through the pipes of the economy, like bad infrastructure. Or bureaucracy that imposes a cost on every company, particularly startups.

It’s not just that reforms will slow economic growth, but that the barriers block the flow of money from people who have them to people who don’t. It’s not just that the country will be poorer overall but also that the poor will remain poor.

Unclogging the pipes may be the only way to lift the poor out of poverty.

Taxes don’t work — if someone earns a crore a year, even a 50% tax rate will leave him with 50 lac, which doesn’t reduce disparity, since that’s more than 50 times as much as the median income! Tax doesn’t work as a way to reduce disparity [4]. So, if taxes don’t work, unclogging the pipes may be the only way to do so.

[1] This doesn’t work if you buy a plot of land and sit on it, or gold, both of which are unproductive assets.

[2] This is different from trickle-down economics, which focus on policies that disproportionately benefit the rich, hoping the benefit will trickle down to the poor. I’m advocating the opposite: policies that disproportionately benefit the poor, by not coming in the way of those with more money giving it to those with less. For example, I believe that the marginal income tax rate in India should be higher, since those earning tens of lacs a year should share more with those less fortunate.

[3] If a big-bang reform to labor laws is politically impossible, it should surely be possible to make incremental ones. For example, if a company hired a certain number of people in the past year, they should be able to automatically fire the same number. Or if a company gives someone a job offer at another company with the same salary, they should be able to fire the person. If there are multiple minimum wages for different jobs, a company should be able to decide which one they will go by, and under no circumstance can this be questioned in court. And so on.

[4] Unless you have a high tax rate like 80%, which will wreck the economy, increasing poverty, not reducing it.