Wealth Flow in an Economy to Reduce the Rich & Poor Gap
Posted in Finance Articles, Total Reads: 411
, Published on 08 June 2016
It is a very curious thing how wealth flows in an economy. When we have more than enough resources for everyone, how some people live in scarcity and others have the overabundance of them. If we imagine economy as a spear out sheet and wealth as grains of sand over it then it only makes sense that over time these grains will get uniformly distributed over the sheet. We call this idea “the invisible hand of economy”. But, we all know this is not so in real world, there are heaps of grains accumulated in some areas and complete scarcity in other places.
To understand this, we firstly have to understand that it is human nature to gather as much resources as we can. It was crucial for our survival when we lived in a hunter gatherer society initially. After that we settled and started farming, the clans which were in proximity of natural resources had better produce and hence were wealthier. But that is in complete contrast with today’s society where the countries which have the largest mineral deposits and other natural resources are the poorest. Clearly the rules have changed, the factors which attracted wealth are now different.
By definition, poverty is the deprivation of resources necessary for survival. But you can have enough resources and still be poor in comparison to Warren Buffet or Bill Gates, this makes poverty a relative term. After a certain point, when the basic necessities are fulfilled, the desire to earn wealth moves beyond survival, it becomes a carrier for esteem. Just like Abraham Maslow stated in his need hierarchy theory. That is why we see so much disparity in wealth distribution within economy. Just the top 0.7% of the richest people own 42% of the total global wealth while bottom 68.7% of the world population hold only 3% of the world’s riches.
Source: Credit Suisse's 2013 Global Wealth Report
Why some part of the world is extremely rich while others are overly poor? In Russia, only 110 people hold about 32% of the nation’s wealth. The reasons for such cases may vary from culture to culture, but the overall fact remains the same that such a disparity exists in nearly all of them. French economist Thomas Piketty explains the reason of the increasing gap between rich and poor. Firstly, the income on capital has grown more rapidly than gross domestic product. Interests, dividends and other returns on the capital have increased by 5 to 6 per cent for last two decades while the GDP has increased only by 1 to 2 per cent. As a result, the gap between rich and poor has increased. Secondly, the rich get better returns on their investment as they are able to employ better advisers, information and technologies which are not available to small investors. While explaining the disparity, Piketty assumes that the wealthy and poor as playing on the same field and competing for the same resources, which is not always true.
Falling rate of global Poverty
Many governments and organizations are working to eradicate poverty. If we look at the latest data released by the World Bank, we see that even as the global population is on an exponential rise, the extreme poverty percentage has actually come down. This development is due to the economic growth in eastern and pacific Asian countries, over the last 15 years. These developing nations have been very successful in reducing poverty levels. In contrast, the condition in conflict driven areas has actually worsened. Sub-Saharan Africa accounts for half of the global poor.
Globally, the growth has been profoundly uneven. We need to analyse the drivers of growth in developing countries so that we can sustainably replicate this throughout the world. In Indian context the official poverty rate has halved from 45% in 1992 to 22% in 2015. Let us look at some cases where people have been successful to recover from extreme poverty.
Market economy system
Let’s go back to our example of economy being sand grains on a sheet, the concentration of sand is around a few pockets, places where business happens in the real world. The flow of wealth takes place from these centres to the rest of the system. The total amount of sand grains the sheet has is the power of economy here. In the real world we can assume such multiple such sheets with different economic power. The flow of wealth between these sheets takes place via conduits where the lower strata does business with the upper strata.
Now, we have mapped real world economy in a three dimensional model. Wealth disparity is an inter and intra strata phenomenon here. For reducing disparity within sheet we need to increase the number of business centres. For reducing the disparity among sheets we need more number of business conduits.
To support the above hypothesis let’s look at two examples form the real world. These are:
• Baripada Mudhi Case: In the Mayurbhanj district of Andhra Pradesh, India at group of women living in extreme poverty started a business of puffed rice snacks. They utilized inputs from nearby villages to produce enough products and sold their produce to big cities. Hence, they became the business centre in their locality and the money started to flow from wealthy cities to their poor locality through them. And the local people which were previously living in extreme poverty started earning more for the same work they were doing earlier. Also, the people of upper strata living in big cities gained access to products which were previously unavailable to them.
• Green Leaf Energy Case: In rural districts of Bihar, India local entrepreneur utilized MNREGA act of government to produce and sell bio-fuel to big oil companies. In this case also the local economy developed after receiving money from big companies.
In both the cases, the projects acted as the conduits between strata and brought more wealth to their respective strata. We can also see that the wealth of the people increases with the proximity with these business centres.
Such business centres can be a solution to bridging the economic disparity in society. But single such unit defeats the purpose, we need numerous such conduits across the economy for even wealth distribution.
Does this mean that emergence of such small business pose a threat to previously established big business centres? Absolutely not. These small business centres create new business opportunities for these already established players. They increase the buying power of people and hence increase the market size for the current companies. Hence, their emergence is in the benefit of the companies. These multiple business makes the economy stable.
We have argued how the distribution of wealth can be made efficient by helping the small business emerge. But leaving each of them to go through business cycles is equivalent to reinventing the wheel. Hence, cooperative organization which provides technology and guidance to these small businesses is a better solution for reducing the global wealth inequality. Such practices have been effective in developing nations and can be replicated globally to reduce wealth gap between rich and poor and also eliminating extreme poverty.
This article has been authored by Nitish Tripathi IIM Kashipur