The Incentive Trap: Why India’s Economic System Breeds Inequality and Solutions

For centuries, most Indians lived in a state of subsistence, hovering near the poverty line. Traditionalists often argue against westernization, pointing to rising inequality and the erosion of an idealized past. Yet this narrative overlooks a critical economic reality: cultural persistence is often a function of stagnant opportunity, not inherent superiority.

Since liberalization, rapid migration and the decline of joint families reveal a deeper shift as changing incentives are reshaping social structures. The Darwinian logic of survival of the fittest has intensified competition, creating winners and losers at an unprecedented pace. But is this purely a market outcome, or a result of distorted incentives in policy?
 

The Principal-Agent Problem in Inequality

The wealthy, acting as rational economic agents, maximize their utility with little obligation to the poor. Why? Accountability fails when incentives are misaligned. In a system where philanthropy lacks tax benefits and corporate social responsibility is merely performative, elites optimize for profit, not welfare.

Meanwhile, the government faces a time-inconsistency problem. It must balance redistribution with growth. Higher taxes on the rich could theoretically narrow inequality, but capital mobility allows wealth to flee jurisdictions with harsh policies. The threat of investment outflow forces governments into a race to the bottom on regulation and taxation.

The Political Economy of Reform Resistance

Why do reforms stop? The rich, a small but powerful group, lobby against redistribution because the losses are immediate and personal. The poor, though numerous, lack coordination. The result is a self-reinforcing cycle:

Business friendly policies such as lower taxes and deregulation attract investment but deepen inequality. Populist welfare schemes emerge as stopgaps, often inefficient and fiscally unsustainable. Elite capture persists, as wealth buys political influence, amplifying the status quo.
 

Breaking the Cycle: Incentives Matter

The solution isn’t nostalgia for a mythical past, nor unchecked capitalism. It’s rebuilding incentive structures. We’ve already seen how smart policy design can work in practice. Take Rajasthan’s Bhamashah Yojana, which boosted girls’ school enrollment by linking cash transfers directly to attendance proving that conditional welfare works better than blanket subsidies. The corporate sector too shows us the way forward. Tata Steel’s century-long peace in Jamshedpur, maintained through consistent investment in worker welfare, stands in stark contrast to Byju’s spectacular collapse despite its $22 billion valuation. The solution isn’t about appealing to corporate ethics, but about restructuring the rules of the game. Make tax benefits contingent on worker investments, implement airtight compliance systems like PAN-Aadhaar crossverification, and create frameworks where long-term stability beats short-term profiteering.

This isn’t idealism. It is practical economics that already works where tried.