ExplainSpeaking: In Biden’s Covid rescue plan for the US economy, lessons for India

The US president has dumped the notions of small government and trickle down economics in his bid to rebuild the American economy

Dear Readers,

Last week, Joe Biden delivered his first joint address to the US Congress as President and it was quite remarkable for several reasons, but two deserve special mention.

More government, not less

Since the time of President Reagan, the dominant paradigm has been that less government is a good thing. But Biden seemed to favour having more government because there are things that only a government can do. To this end, he announced the eight-year-long American Jobs Plan — “a once-in-a-generation investment in America itself… the largest jobs plan since World War II”.

“Universal public schools and college aid opened wide the doors of opportunity. Scientific breakthroughs took us to the moon. Now we’re on Mars, discovering vaccines, gave us the internet and so much more. These are investments we made together as one country. And investments that only the government was in a position to make,” he said looking back at the US’ past to argue for future government investments in these critical areas.

Biden was clear that creating jobs was the need of the hour for the US economy and that too jobs for the working class. “Nearly 90 per cent of the infrastructure jobs created in the American Jobs Plan do not require a college degree. Seventy-five per cent don’t require an associate’s degree. The American Jobs Plan is a blue-collar blueprint to build America,” he said.

He said there are good people on the Wall Street but the US was built by the middle class and the unions. To further boost the bargaining ability of the working class, he called on Congress to pass the Protect the Right to Organize Act, which will support the right to unionise.

Further, he argued in favour of raising the minimum wages in the country and providing equal pay to women. “…let’s raise the minimum wage to $15. No one… working 40 hours a week…should live below the poverty line. We need to ensure greater equity and opportunity for women. And while we’re doing this, let’s get the Paycheck Fairness Act to my desk as well. Equal pay.”

Biden did not stop there. Referring to the US’ competition with autocracies such as China, Biden said: “…we also need to make a once-in-a-generation investment in our families and our children. That’s why I introduced the American Families Plan tonight, which addresses four of the biggest challenges facing American families and, in turn, America.”

The first of these four challenges is access to good education. Here, Biden wants to increase universal public education from 12 to 16 years as well as give increase grants and invest in historical Black colleges and universities, tribal colleges, minority-serving institutions because these institutions don’t have the endowments.

The second challenge is access to quality, affordable child care. The new plan aims to guarantee that low- to middle-income families will pay no more than 7 per cent of their income for high-quality care for children up to the age of 5. “The most hard-pressed working families won’t have to spend a dime,” he said.

The third element is to provide up to 12 weeks of medical leave, paid medical leave so that no one should have to choose between a job and taking care of themselves or their loved ones.

The fourth element of Biden’s plan puts money directly into the pockets of millions of Americans by expanding tax credits for every child in a family — aimed at helping more than 65 million children and cutting child care poverty in half.

In addition to this, Biden proposed to bring down the healthcare premiums and the price of prescription drugs. “This is all about a simple premise: Health care should be a right, not a privilege, in America,” he stated.

Few would argue that an economy ravaged by the horrors of the Covid pandemic doesn’t need these measures. However, the obvious query is: How will the Biden administration pay for the jobs and family plans?

This is where the second bit of the speech becomes relevant.

Bottom up/Middle out economics instead of “Trickle down” economics

To finance these plans, Biden junked the other long-held notion: the so-called “trickle down” economics (TDE). “…it’s time for corporate America and the wealthiest 1 per cent of Americans to just begin to pay their fair share,” announced Biden.

Arjun Jayadev, a Professor of Economics at Azim Premji University, explains TDE as follows: “It started during Reagan’s time with a reasonable idea that governments need to find the right level of taxation to maximise revenues. That’s the Laffer Curve, which underscores the point that if the tax rate is too low, revenues would be low but if the tax rate is too high, even then the revenues would fall because they would disincentivize work. However, in practice, this idea morphed into a belief that if you tax anyone who has the ability to invest and create jobs, you’ll damage the economy.”

TDE argued that it doesn’t matter whether the rich get richer — far more rapidly than the rest of the economy — as long as everyone gets richer.

Thanks to this belief, several advanced countries such as the US and UK gave tax breaks — both on direct and indirect taxes — to the rich and business classes of the economy in the hope that doing so would boost economic growth, create jobs and raise average incomes. Of course, tax breaks meant that governments did not have adequate tax revenues to spend directly on the economy. And this is where the first notion — small government — reinforced TDE. A small government, which did not directly provide healthcare and education etc., would not need as many revenues.

The only problem is, as Biden also stated, “trickle-down economics has never worked. It’s time to grow the economy from the bottom and the middle out.

Biden is not wrong — inequalities have been going up sharply not just in the US but across most countries.

Robert Reich, professor of public policy at UC Berkeley points to a study published in December 2020, titled The Economic Consequences of Major Tax Cuts for the Rich, by David Hope and Julian Limberg, which shows that the last 50 years were a period of falling taxes on the rich in the advanced economies.

“They reviewed data over the last half-century in advanced economies and found that tax cuts for the rich widened inequality without having any significant effect on jobs or growth. Nothing trickled down,” wrote Reich in his blog.

A 2015 IMF discussion note explains why policymakers need to focus on the poor and the middle class.

“Our analysis suggests that the income distribution itself matters for growth as well. Specifically, if the income share of the top 20 per cent (the rich) increases, then GDP growth actually declines over the medium term, suggesting that the benefits do not trickle down. In contrast, an increase in the income share of the bottom 20 per cent (the poor) is associated with higher GDP growth. The poor and the middle class matter the most for growth via a number of interrelated economic, social, and political channels,” it concluded.

Given this evidence, perhaps nothing captures TDE better than what noted economist, and a former US Ambassador to India, John Kenneth Galbraith said: “Trickle-down theory — the less than elegant metaphor that if one feeds the horse enough oats, some will pass through to the road for the sparrows.”

So, what is the significance of Biden’s speech for India’s economy?

Biden’s strategy — big government spending push as well as focusing on raising revenues from the rich and the business class to rebuild the economy — is in stark contrast to Prime Minister Modi’s approach.

Modi had come to power in 2014 with the promises of “Minimum government, maximum governance” and a cut in corporate tax rates. While he seemed to have dithered in the first term — often attributed to the “suit-boot ki sarkar” jibe by Rahul Gandhi — since 2019, when he started his second term, PM Modi has tried to repeatedly bolster the case for reducing the role of government in the economy and offered a historic corporate tax cut in 2019.

During the Independence Day speech in 2019, PM Modi even exhorted the public to “recognise and encourage the wealth creators of our nation”.

“In our country, certain wrong beliefs have come into existence. We have to come out of those mindset. Those who create wealth for the country, those who contribute in the nation’s wealth creation are all serving the country. We should not doubt our wealth creators… They should receive more honour. If wealth is not created, wealth cannot be distributed. Further, if wealth is not distributed we cannot uplift the poor sector of our society,” he had said then.

The only trouble is: With growth decelerating to around 4% in 2019-20, especially on the back of sharply declining private consumption demand, businesses did not see it worth their while to invest and create new jobs. In fact, the estimated Rs 1.5 lakh crore (or Rs 1.5 trillion) of revenue foregone on account of the corporate tax cut in 2019-20 was simply pocketed by the businesses to boost their profits.

Corporate profits again grew by between 20%-25% in 2020 even as the rest of the economy was struggling with the Covid pandemic. This time the profits were achieved as companies fired employees and cut costs.

With the pandemic raging on in 2021 and weak growth prospects for the next few years, it is hard to imagine why India’s private sector will take the lead in making new investments and creating new jobs when existing capacities are still lying unused.

At the same time, Indian economy has seen a sharp rise in inequalities. The middle class was likely down by one-third in 2020 and around 75 million were pushed below the poverty line even as India became the country with the third-most billionaires in the world.

The second Covid wave has also shown how investment in public healthcare — just this year, the Union Budget reduced the allocation for health ministry by 10% — has no substitutes.

The question is: Should India take a leaf out of the Biden prescription to radically alter its growth strategy coming out of the Covid pandemic?

✍️ On a different note, I want to thank the regular readers of ExplainSpeaking as this weekly dispatch completes 52 weeks of uninterrupted transmission today.

You can share your thoughts and queries on this piece or any other topic related to the economy on [email protected]

Please continue to mask up and stay safe,

Udit

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