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Income Distribution and Aggregate Demand in the Indian Economy
Does there exist a trade-off between labour income share and output growth rate? Or does a reduction in the wage share reduces the output growth rate? These questions remain central for analysing the impact of change in income distribution on the output growth rate. Since the dilution and suspension of labour laws involve exogenous changes in income distribution, the impact of such policies would depend on the relationship between income distribution and aggregate demand. This paper attempts to lay bare this relationship for the Indian economy through an empirical analysis of India’s macro data and a theoretical model based on the regression results.
The author is grateful to Rohit Azad, Anamitra Roychowdhury, Arjun Jayadev, Amit Basole, and the referee for their comments. The usual disclaimers apply.
Notwithstanding the variations across states, there are at least three broad features of recent changes in labour laws which can be argued to bring about a decline in the share of wages in output. These are (i) dilution of the notion of minimum wage rate, (ii) extension of the working hours, and (iii) increase in flexibility to hire and fire (Roychowdhury 2020; Sood and Nath 2020). If the wage share is defined as the ratio between real wage rate per worker and output per worker, where output per worker is the product of output per work hour and the number of work hours per worker, then such modifications in the labour law would aim to reduce the wage share either by reducing real wage rate or increasing the work hours per worker.
Unlike a period of boom when the labour income growth rate may get pulled up despite a fall in its income share due to the presence of exogenous stimuli, during the period of depressed demand such as the present one, the impact of a state-induced reduction in wage share on labour income growth rate would depend upon the relation between the wage share and growth rate. In the absence of an inverse relationship between the wage share and growth rate, reduction in the labour income share would be associated with a further fall in the labour income growth rate in the midst of what has already been an unprecedented crisis. But does such an inverse relationship exist in the Indian economy? Or can a reduction in the wage share itself reduce growth?
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