How the black economy is (really) making poverty worse in India

“I arrived at my estimate of the figure of the black economy in 2012-2013 as 62 per cent of GDP. Assuming that it has remained the same for 2016-2017, it works out to Rs 93 lakh crore.”

The economic aspects

Most of the key economic problems India faces can be linked to the existence of a large black economy. This should not occasion surprise, for no economy can thrive where billions of dollars are spirited out, black transactions abound in the stock and real-estate markets, and where even matters like getting admission for schoolchildren requires bribes. What is being revealed by official agencies or in the media with relentless regularity is only the tip of the iceberg.

Due to the black economy, government policy fails and society is unable to achieve its goals, especially in critical areas like literacy and health. Consequently, a vast majority of Indians live in miserable conditions. For all the big talk of party spokespersons and the pseudo-nationalism displayed by ruling party cheerleaders, the unfortunate truth is that today the quality of life of an extremely large number of Indians is poorer than that found in most parts of the world. Worse, most of the schemes floated by governments have done little or nothing to improve the situation. This is because of the negative impact of the black economy.

As finance minister in the UPA government P Chidambaram said in his budget speech in 2005: “...outlays [expenditures] do not necessarily mean outcomes”. In 1987, Prime Minister Rajiv Gandhi said that out of every rupee sent to the field, only 15 paise reached the ultimate recipient it was intended for. (It must be clarified though, that he did not mean that all of it was lost due to corruption, bureaucratic inefficiencies also contributed to this dissipation.)

The failure of government spending is not the only thing the black economy impacts. It is also the reason why government policy is not implemented in a way that benefits citizens. Whether it is environmental regulation or industrial location or urban zoning or traffic lights, all laws are routinely violated. No wonder that at a low level of per capita income, India has some of the worst air and water pollution in the world. Due to insanitary conditions and water pollution, most people suffer from poor health resulting in low labour productivity.

Literacy is low because money sent for constructing schools is often siphoned off and teachers are either not appointed or absent themselves. According to a Pratham report, 50 per cent of schoolchildren in the fifth grade are unable to read grade two books, and as a result are condemned to work at low levels of productivity for the rest of their lives and are likely to remain poor.

The effects of the black economy are not just felt by economically deprived sections of our society, but impact the work ethic of elite sections of society too. Given the hurdles that have to be overcome at every step, Indians do not achieve (with few exceptions) world standards in anything, whether in sports or in technology. As has been shown, this is not because there is a lack of resources, but because these resources are either siphoned off or poorly deployed. As the situation worsens, individual citizens are alienated from society, making any sustained or collective action to turn things around difficult.

Impact on inequality and poverty

In a study I made over two decades ago, I estimated that the black economy was concentrated in the hands of, at most, 3 per cent of the population in 1995. Yes, there is petty corruption throughout society but this is insignificant compared to the black incomes earned by those in the upper echelons.

It was assumed then that the bottom 40 per cent in the income ladder were around the poverty line. In 1995, if the ratio of incomes between the top 3 per cent and the bottom 40 per cent in the income ladder was 12:1 in the white economy, it became 57:1 if the black economy were included.

The percentage of those earning substantial black incomes would only have increased since 1995. But if it is assumed that the percentage has remained the same (at about 3 per cent) and the fraction of those at the poverty line is also similar, the disparities would be much larger now given that the black economy has grown significantly and the disparities between the rich and the poor too have grown significantly after 1995.

Thus, today, in a vast and poor population of 1.27 billion, there are 39 million who are well off – the size of a European nation – who can afford all the luxuries, because many of them have large black incomes in addition to their high white incomes. This explains the existence of vast poverty in the midst of glitzy markets and the ostentatious consumerism of the wealthy.

Another manifestation of such skewed income levels is that the savings propensity of the overall economy is higher than recorded in the white economy. This is a consequence of the fact that the rich, with their high incomes, tend to save more than the poor who, of necessity, have to consume their entire income.

Absolute poverty is also impacted by the growth of the black economy. The increase in social waste has meant that the increase in GDP does not translate into a higher level of welfare of the people.

I have touched upon the indirect cost of the black economy, but let us go a little deeper into the issue. For example, the increased levels of pollution of water and air, due to the violation of environmental rules and regulations, has led to increased incidences of disease. This has especially impacted the poor, whose living conditions are deteriorating not only in the cities but also in the villages due to the excessive use of pesticides and chemical fertilisers, leading to the pollution of water bodies. The cost of treatment has risen sharply because of the liberalisation of prices post 1991 and the decline in the public health system.

A study from Kerala, between 1987 and 1996, showed that there has been “mediflation’ with increases not only in medicine costs but also in doctor’s fees, laboratory charges, etc. The most disturbing aspect noted is the rapidly increasing financial burden on the poor. It is noted that for the well-off sections the rise was 326 per cent but for the poorest group it was 768 per cent and for the next higher category 1,002 per cent.

The percentage of income spent rose for the rich from 2.18 to 2.44, but for the poor it went up from 7.18 to 39.63. In other words, even as things ostensibly change for the better, they are actually getting worse.

Education is being increasingly privatised, thereby raising the cost of education for all segments of society. While the very poor may not send their children to private schools, the slightly better off do. Thus, almost the entire gain in income has been wiped out for the poor by the increase in health costs, and for the slightly better off the gain has been wiped out by the increased costs of education and health.

Unfortunately, our wholesale price index (WPI) does not take health and education costs into account, so our inflation index does not reflect these price increases. So while the official data may show an increase in real wages they may actually be falling when all prices are taken into account.

Finally, due to the demonstration effect of rampant consumerism among the wealthy who have benefitted from the black economy, the aspiration levels of the poor have risen and many of them also want to possess mobile phones, televisions and other components of “achhe din”. In many parts of the country, these things have become the “minimum necessary social consumption” and that changes the definition of the poverty line.

After meeting these expenditures there is inadequate income left for food and other essentials. Add to this the rise of social evils such as alcoholism and drug abuse due to the pressure of keeping up with the modern pace of life and what it costs to sustain such habits among the poor, and it becomes clear that the deleterious effects of the black economy are far wider than it may seem at first glance.

Thus, while for the government poverty is declining because real wages have risen, the poverty line itself is changing due to the impact of the black economy and the demonstration effect associated with it. Put differently, it would be incorrect to say poverty is declining because what constitutes poverty is changing all the time. Not taking the black economy into account in policy-making makes the problem more intractable.

Excerpted with permission from Understanding The Black Economy And Black Money In India: An Enquiry Into Causes, Consequences And Remedies, Arun Kumar, Aleph Book Company.