Are free gifts affecting India’s economic development?

In an address given at the Delhi School of Economics last week, NK Singh, chairman of the 15th Finance Commission, said, Warned about how the race to give free gifts to voters could be a “quick road to fiscal disaster”, He also said that free gifts can be detrimental to a country’s long-term economic development and stressed the need to differentiate between productive and unproductive forms of welfare spending. In a conversation moderated by Prashant Perumali, Renu Kohli And Himanshu Investigate whether there is a case for eliminating freebie culture. Edited excerpt:

Is there a declining trend in the financial position of the states? Is freebies the reason for this?

Renu Kohli: When the argument is framed as financial stability versus free gifts, a binary answer is often not possible. So let me be clear that there are different types of freebies. Some of them are extremely justified, some of them are not. As far as fiscal stability and fiscal decline are concerned, if we look at the welfare spending of the states, and if it is sustainable and affordable, it is fine because it is the prerogative of the political executive. Having said that, we must understand what we mean by fiscal stability. Broadly speaking, fiscal stability is a state in which a government is able to deploy its fiscal policy toward long-term economic objectives, which are high employment and growth rates. This leads us to measures of fiscal stability. If you look at the study of state finances conducted by the Reserve Bank of India, you find that since 2005, overall, states have adhered to limits in terms of their gross fiscal deficit, which is the difference between total revenue State and total expenditure.

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The mandate is within the limits of the Fiscal Responsibility Act, which allows them to keep the gross fiscal deficit within an aggregate limit of 3% of GDP. The only years – apart from the pandemic years – when these limits were breached were 2009-10, 2015-16 and 2016-17. 2009-10 was a critical year and 2015-16 and 2016-17 were years of power sector reforms in which the debt of the power sector was taken over by the state governments. Second, what is the trajectory of outstanding debt? In the case of states, the reduction in outstanding debt has actually progressed quite well. From a high of 31% of GDP, it fell by about 10 percentage points to about 22% of GDP by 2014-15. After that it has increased by about five percentage points till FY20. If we compare it with the track record of the central government, then the central government has never been able to adhere to the fiscal deficit limit. Second, when it comes to debt reduction, the central government’s debt-to-GDP limit, which was supposed to be 40%, has now crossed 90% of GDP. Therefore, the problem of fiscal stability at the central level is under greater pressure.

Himanshu: We need to look at the definition of freebies itself. The term “free gift” gives you the impression of something that is a dole or a gift given to the population. But then freebies can be of different types. Some types of spending may be questionable in view of populist pressures or elections. But given that inequality has increased over the past 30 years and some level of crisis has occurred in the last decade, any relief to the population in the form of subsidies may not be unreasonable. It may indeed be necessary for the economy to continue on its growth trajectory. On the financial front, noting that after 2017, when we have the Goods and Services Tax (GST), which is more or less taking away the revenue generating power of the states and given that the responsibility for the majority of welfare expenditure lies Under the jurisdiction of the states, the hands of the states are squeezed. Therefore, fiscal stability is not just about expenditure but also about revenue. And keep in mind, the Center is engaged in giving free gifts not only to the poor people but also to a large number of corporations.

NK Singh claims that poverty reduction has accelerated under the Modi government. How much of this is due to development versus welfare measures taken by the Centre?

Himanshu: We do not have official estimates of poverty after 2011-12. The only guess we have is from several independent studies conducted by private researchers. And I completely disagree with NK Singh’s claim that the poverty reduction rate has doubled under the Modi government. No study confirms this, including an IMF study, a World Bank study, or a consumption survey. In fact, there is at least one study that concludes that the rate of poverty reduction has slowed under the Modi government. There is also a general consensus that welfare measures such as the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) and the public distribution system have contributed to poverty reduction. The strengthening of these programs has certainly contributed to poverty reduction. This does not mean that development has no role in alleviating poverty. If growth in the Modi years had been as good as it was before, perhaps the rate of poverty reduction would have been higher. So, I don’t think it is a question of welfare versus development. I’m a bit hesitant to call welfare measures freebies because they can be essential not only for poverty reduction but also for development. Remember, we are in recession simply because aggregate demand in the economy has fallen. And I think welfare spending has been able to at least prevent consumption demand from falling further.

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Renu Kohli: The idea of ​​estimating poverty on the basis of private final consumption on the basis of national accounts was rejected long ago. Therefore, it is unacceptable to assess poverty on this basis. No consumption expenditure survey has also been conducted. We have to question the poverty estimates coming from both the World Bank and the IMF. This is for two reasons. One is that at a time when the government is claiming that formality has increased, there is no basis to believe that income distribution has not deteriorated as a result of formality. Second, at a time when free food is being provided, where is the proof that in the absence of any consumer expenditure survey, the underlying income of the poor remains intact? There is no way to install it. Also, the fact that the latest survey was canceled and never published raises suspicion that poverty has increased.

What proportion of the expenditure by the states is productive only for the purpose of securing votes in elections?

Himanshu: Well, in a democracy where political parties try to get votes from every section of the population, obviously the state governments try to give some kind of relief to the voters. I am definitely in favor of expanding, for example, MGNREGA type expenditure and subsidies in the form of food ration schemes. These go a long way in increasing the productive capacity of the population. So, they’re not just drools. They build a healthy and strong workforce, which is a necessary part of any growth strategy. It is similar to state expenditure on education or health. These can be called long term investments to improve the productive capacity of the population. But yes, apparently there are cases where the state governments have gone astray and indulged in giving all kinds of freebies or gifts. But when it comes to just loan waivers, I am not in favor of these as they have unintended consequences such as destroying the entire credit culture and blurring the very basic question of why it is so because of the farming community. is a big part. Getting caught in the debt trap again and again.

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We need to talk about some of these issues in a broader context to see if they really contribute to development. Do they really contribute to poverty reduction, or are they only being done to gain short-term gains at the cost of long-term harm? We are aware of free electricity given to rural communities in various states which has sometimes led to disastrous consequences of drop in water level, wastage of electricity and many other things. There are nuances to this issue, and one has to go into those specifics to make a final decision on whether a certain welfare expense is necessary. Lastly, some people are questioning the subsidies going to education like laptops and other things. Some of them have now become a necessity to increase productivity, knowledge, skills and many other things. Therefore, we need a more nuanced understanding of this issue.

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Renu Kohli: There is no justification for providing 200, 300 or whatever number of power units to the middle class or the urban population, who in general are regular income earners. I have a slightly different take on loan waiver in view of agriculture being a very expensive and extremely risky venture. It is one of the riskiest activities as compared to manufacturing or any service segment. And there are always ways to restructure bank loans to medium and small enterprises in the event of a downturn in the business cycle or any extraordinary setbacks. Now, we can talk about loan waiver in the light of weather and other risks and also about the fact that crop insurance has always failed to address the shocks in agriculture. Also, we are in a position where Direct Benefit Transfer can be used to directly give loan waiver to distressed farmers and the cost of rebate is immediately taken over the budget of the government and financial intermediaries are not involved. Second, the trend of unproductive spending is not more pronounced at the state level than at the Centre. If we look at the expenditure of the social sector, there is a trend of growth at the state level, but the growth trend at the central level is extraordinarily high. And if you look at the core sector plans, the revenue expenditure component ranges from 65-68%. Therefore, about two-third of the expenditure is revenue expenditure. The issue of unproductive and productive spending needs to be viewed in this light and in the light of rising interest payments.