Archive for June, 2014

The Welfare State is an Ill-fare State

Before I am accused of being a right of the road, capitalist pig, let me clarify that I am no unabashed advocate of the free market. I recognise that the market cannot meet the needs of groups which lack the skills and purchasing power to offer their services and buy the goods and services essential for their day to day living. I endorse the view that the state has the responsibility to arrange for the provision of public goods like quality healthcare and education, which are beyond the financial capabilities of large sections of the population. Why is it then that I harbour strong reservations about the Indian state having pushed the “welfare” envelope so strongly over most of the first sixty years of independent India?
I think the problem lies in thinking that redistribution can be pushed as a primary policy without creating the conditions for sustained growth. The Indian state has too often relied on distributing fishes to the populace without investing in teaching them how to fish for themselves. The result has been the development of an ‘entitlement’ mentality in the population, with the state being expected to deliver quality goods and services across a wide spectrum of sectors. There are two issues in such an approach – first, the state cannot mobilise the finances required to meet such a vast array of entitlements and, second, the quality of goods and services delivered rarely meets the expectations of the groups for which they are intended. The consequences are faced by the people in the form of price inflation (a corollary of large budget deficits) and crumbling public services, manifest in the most evident, wretched manner in decaying urban habitations. Lest anyone harbour the thought that these are manifestations only in an emerging economy, let me point out that the largest economy in the world, the United States of America, is beset with the same problems.
The inherent complications in the Indian tryst with the welfare approach can be best exemplified by studying its consequences in three sectors: jobs, housing and food. An over-reliance on the public sector as the engine of growth meant that jobs had to be created largely in government and public sector enterprises. Since neither of these institutions had to face the discipline of the market place, we ended up with bloated public institutions, where performance was never the criteria for keeping one’s job. Politicians vied with one another in creating sinecures for their constituents, the worst offenders being the railways and the municipal corporations. Getting a government job is still the ‘holy grail’ for large segments of the citizenry. At the same time, the over-zealous state felt it had to guard the worker from the evil designs of the private sector. So we have the Industrial Disputes Act, the Contract Labour Act, etc., which are ostensibly meant to safeguard workers’ rights, but which end up damaging the very basis for providing secure livelihood. Labour legislation in India has virtually precluded any laying off of workers even if the concerned firm is in no position to continue operations. Nor has specific provision been made for social safety nets to protect the worker’s (and his family’s) existence till he secures alternative employment and for retraining provisions to enable the worker to adjust to changes in technology and processes. Employers have, therefore, taken recourse to employing contract labour for years on end, creating a huge mass of unorganised labour. Apart from breeding unrest in workers with highly uncertain futures (Maruti is a recent example), this also lowers labour productivity. There is also the tendency to go in for capital-intensive technology, a disastrous development for a labour-rich economy like India.
Again, an overriding concern for the welfare of tenants and the state-sponsored provision of housing for economically weaker sections of society saw the emergence of laws controlling rents and restricting urban land ownership. The Rent Control Acts, designed to regulate rentals in urban areas, were introduced between the end of the First and Second World Wars and have survived for over seventy to eighty years in a number of states of India. The Urban Land Ceiling Act, enacted in 1976, served to choke the stock of urban land available for development. These two Acts, coupled with politico-bureaucratic control of the land use process in urban areas, has led to a totally arbitrary, unpredictable manner of urban development, exacerbated by the rapid inflow of migrants to cities in search of work. Government efforts at directly adding to the stock of housing have been woefully inadequate and of shoddy quality. Attempts to associate the private sector through slum redevelopment schemes have generally failed, with allegations of favouritism and large-scale corruption.
However, it is in the area of food provision that public policy has fumbled the most. The National Food Security Act seeks to provide subsidised foodgrains to a majority of the Indian population. This process is to be administered through a mechanism that is riddled with inefficiency and leakages, right from the Food Corporation of India at the central level to the civil supplies machinery at the district level. Inspite of boasting of a decades old public distribution system, the state has failed to check food inflation, with grim consequences for the poor. Inadequate attention has been paid to promoting agricultural productivity and developing farm to customer supply chain networks. Soil conservation is an area that has been talked about incessantly, without any real commitment to it: major programmes of soil conservation works funded by rural employment guarantee schemes like the MGNREGA could well have augmented groundwater levels and promoted efficient agricultural practices. Foreign direct investment in retail is another area where kneejerk reactions motivated by specific interest groups have obstructed the introduction of technologies and systems that reduce food wastage and guarantee secure incomes for farmers.
What is evident from the three examples above is the way in which misplaced welfare concerns have not only failed to achieve their intended objectives but have also inhibited the adoption of long term measures that could have laid the foundations for sustained economic growth and development. Governments come and governments go in India but the same blinkered approach to public policy persists. Even today, politicians of different hues seem to think that welfare measures, like free rice, loan waivers, consumption loans, etc. lead to poverty reduction. Such measures fail to address the root problems of inadequate purchasing power and access to credit. Not only that, the huge public financial outlays on these and other welfare measures limit the capacity of the state to invest in physical and human infrastructure, which alone can be the basis for future growth. European countries moved to a welfare state after the foundations for sustained economic growth had been laid. By trying to put the cart before the horse, the Indian state is achieving neither its welfare objectives nor its growth goals.

Demonetise and Develop

Indians have a fascination for black money. If they don’t generate it, they love to talk about it. And yet they share a major misconception about it — it is as if the money itself has a colour, either black or white. They would do well to heed what an Economics Professor of mine used to say “Money by itself is neither black nor white; it depends on the use to which it is put.” To give you an example, let us say you pay a hefty donation of Rupees ten lakhs to get your daughter a seat in a private medical college. You have raised this amount from your hard-earned life savings, from the gratuity and provident fund paid to you when you retired (and, therefore, indisputably white money). But when the college has to park this money, they will not take recourse to their normal banking channels: the funds will be routed through avenues that seek to evade the attention of the income-tax authorities. White money has, in a trice, been converted to black money, with a change of user.
Why does this transaction hit the normal economy? Well, for one, the government is denied its share of tax revenues, impacting public expenditure. The money could be invested in assets like land or gold, driving up their value and fuelling inflationary trends. Or it could be spirited out of the country through hawala channels, decreasing the money supply available for lubricating economic activity within the country. The real killer is the multiplier aspect of such behaviour — when such transactions outside the banking system become the norm, a huge parallel economy develops alongside the regular economy. Governments may then find that their interventions to stabilise inflation or currency rates are having little impact, since the demand for and the supply of money is operating outside the regular system.
How can governments tackle this problem? Lowering tax rates does not solve the problem: rates have come down over the past twenty years but the black money menace is more pronounced than ever. When there is an incentive to pay zero income tax, there are strong motivations to conduct transactions outside regular banking channels. So we have the spectacle of professionals accepting fees in cash and not declaring their incomes and land/building sale transactions being conducted in a black and white combination.
Two possible solutions suggest themselves: (a) Demonetise higher value currency notes to make cash transactions more cumbersome in terms of volume; (b) legally mandate that all transactions above a certain value, say, Rs. 10000 have to have an electronic footprint. On demonetisation, we have the example of countries like the USA, where the highest currency denomination in current use is 100 US dollars (higher denominations were not even printed after World War II). Unfortunately, we are headed the opposite way in India — we introduced 1000 rupee currency notes and are now contemplating 1000 rupee coins as well. It would seem that we are trying to make things as simple as possible for people who wish to despatch trunk loads of cash for illegal payments. If India were to demonetise all currencies of Rupees 100 and above, there would be a tenfold increase in the volume of cash that has to be carted around for cash transactions. This is where the second solution kicks in. Since all transactions above Rs. 10000 have to come through official channels (which are electronically monitored), cash withdrawals by an individual customer can be restricted to a certain value per month, say Rs. 25000. Barring minor payments for items like bus tickets and vegetable purchases, there is no need to rely on cash purchases at all.
Electronic payments would necessitate opening of electronic bank accounts for all citizens above eighteen years of age, an objective the Nachiket Mor Committee on Comprehensive Financial Services has already stressed in its recent report to the Reserve Bank of India. Issuing Aadhaar and/or PAN cards to all citizens would enable linkage of these cards to the account, to keep track of receipts and payments and ensure compliance with tax and other laws of India. The electronic footprint would also restrict cash withdrawals by an account holder to the amount specified above, to prevent huge cash volumes illegally exchanging hands. Who knows, this may well discourage payments at election time and speed money payments, till Indian jugaad comes up with some other ingenious solution. Payments above Rs. 10000 can be through bank transfers, internet transfers, cheques and/or mobile money.
There is another virtuous cycle that will come into operation once the above measures are introduced. We love to repeat ad nauseam that “of every rupee meant for a poor beneficiary, only 15 paise reaches her”. An obvious solution is the introduction of cash transfers. Instead of cash being paid, the amounts are directly credited to the account of the beneficiary. A combination of conditional and unconditional cash transfers can be employed. Where the amount is meant for daily use as in old-age pensions, there would be no restriction on the free use of the funds by the beneficiary. Where the funds are linked to fulfilment of a specific condition like the purchase of food grains, payment for health care or school vouchers, the amount would be electronically transferred from the beneficiary’s account to the institution/person providing the good/service when the good/service has been provided to the beneficiary. This should pose no technological problem to our IT geniuses, given that the National Securities Depository Limited (NSDL) is already handling such a large volume of capital market transactions. In fact, there is no reason why the same NSDL system cannot be fruitfully employed for this purpose as well.
We can talk about the scourge of black money and poor service delivery till the cows come home but unless we bring in reforms on the lines suggested above, I do not see any meaningful solution to these problems. The marriage of modern technology with existing systems can definitely create the conditions for sustained, inclusive growth and development.