Striking the Right Balance

Welfare programmes, aimed at social inclusion, often come at the cost of investment in infrastructure and governance. It is thus important to balance the dual imperatives of growth and inclusion. Team Inclusion analyses

01 January, 2014 Economy, Research Reports
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Nobody with their heart and mind in the right place will object to food being provided for the hungry or shelter for the homeless. But, if welfare measures are overtaken by or equated with populism and that too at the expense of other growth-oriented polices, then it becomes a problem. Populism as a political tool has its origins in the annals of history. As Gurcharan Das writes in his book India Grows at Night: “Populist giveaways have always been a great temptation. Roman politicians devised a plan in 140 BC to win votes of the poor by offering cheap food and entertainment – they called it bread and circuses.”

The bigger question is how will all these social schemes be financed? It comes at the cost of investment in infrastructure, governance and longer-term prosperity. The fiscal deficit target stands at `5,135.90 billion, or 5.1 per cent of GDP for 2012-2013. A case in point is that of the recently passed National Food Security Bill. Concern is being expressed that capital expenses, such as infrastructural projects, might be slashed to pay for the food subsidies and meet deficit-reduction targets. The government itself has estimated that the food bill would increase its spending on food subsidies by around $4 billion to roughly $20 billion. (Niharika Mandhana, “India Approves Landmark Food Subsidies: Parliament passes legislation expanding aid to nation’s poor”, The Wall Street Journal, 2 September 2013.) This comes at a time when the fiscal deficit is already out of hand.

Economic growth can be defined as the steady growth in the productive capacity of the economy (and so a growth of national income). This growth is measured by an inflation adjusted index known as Gross Domestic Product. Whereas social welfare can be defined as governmental provision of economic assistance to persons in need and improvements in social welfare can be measured by the Human Development Index.

Those who support a welfare state are often citing the greatest Western democracies (particularly in Europe) which have run huge welfare states with the government taking care of its citizens from the moment they were born. But let us not forget that the Western democracies became welfare states only after almost 100 years of economic growth. And given this, India is indulging in “premature welfarism”. “A nation with a per capita income of $1,500 cannot protect its people from life’s risks as a nation with a per capita income of $15,000 could,” adds Gurcharan Das.

Let us not forget that Western democracies became welfare states only after almost 100 years of economic growth. Given this, some say, India is indulging in “premature welfarism”

That’s one part of the argument. In order to finance these programmes, the government will have to borrow. Once it does that it will crowd out borrowing by the private sector and thus further bring down investment in infrastructure and hence longer term prosperity. There is no example of a premature welfare state in the history of mankind rising to economic prosperity. An excellent example of a country that tried and failed is Brazil. India is making the same mistakes now that Brazil did in the late 1970s.

That is not to say that economic and social policies cannot be compatible or are ‘bound to be at war with each other’. Neither is growth the enemy of social equity. In fact, if we look back, the liberalisation in 1991 and subsequent reforms definitely put India on the high-growth trajectory. The growth generated surpluses that allowed us to invest in social welfare. There is a subtle correlation between the two. It has been seen statistically that when India experienced economic growth of 6-9 per cent, public revenue gradually increases to 10-12 per cent. This itself implies that if we fall off the growth track, those very same surpluses will not be generated. Therefore, the monies to fund social spending dry up. And, withdrawal of welfare measures already initiated is equivalent to political hara-kiri.

The Californian professor of economics, Peter H Lindert (Peter H Lindert: Growing Public. Social Spending and Economic Growth since the Eighteenth Century. Cambridge University Press. 2004.) notes that support for the poor takes a lower share of income in states with worse poverty and inequality. This is a basic paradox of history, according to Lindert. It is in the prosperous world with lower inequality that the poor gets the most generous support, not in countries with the median income well below the mean income and a concentration of power in the hands of the rich. Simply put, in times of growth everybody prospers.

In the last few years public expenditure on social programmes has increased dramatically from 9,000 billion in the Tenth plan period to 22,000 billion during the Eleventh Plan period with a step up of over 149 per cent. In the Eleventh Plan period nearly `7,000 billion has been spent on the 15 major flagship programmes. This sharp increase is unprecedented and one wonders how the fund flow for this level of spending will be sustained over time. A number of legislative steps have also been taken to secure the rights of people, like the Right to Information Act, the MGNREGA, the Forest Rights Act, and the RTE. Thus the rights are constitutionally guaranteed and many achievements have been recorded, but there are also pressing issues like leakages and funds not reaching the targeted beneficiaries.

While the Direct Benefit Transfer (DBT) system with the help of the UID can help in plugging many of these leakages, there is enough scope for expenditure reduction even in social-sector programmes through convergence (integration and combining). A welcome development was the merger of the JBY with the AABY. Recently, there were also news reports of the possibility of merging the housing scheme Indira Awas Yojana (IAY) with the MGNREGS, so that the latter is utilized for asset building more effectively.

There are many other such areas where convergence can take place. For example the JSY, Janani Shishu Surksha Karyakram (JSSK), and Indira Gandhi Matritva Sahyog Yojana (IGMSY) have many overlapping features and the same beneficiaries. This calls for a careful exercise in identifying overlapping schemes and weeding out or converging them. A threshold level could also be fixed for the schemes as a critical minimum investment or outlay is needed for any programme to be successful. The Committee on ‘Restructuring of Centrally Sponsored Schemes’ has suggested that new centrally sponsored schemes should have a minimum Plan expenditure of `100 billion over the Five Year Plan and should be included under flagship schemes.

Rapid GDP growth has financed, not hindered, rapid growth of social spending. The Economic Survey (2009-10) says gross central revenues more than doubled in 2004-05 and 2009-10, from `3,040 billion to 6,410 billion. This helped finance the social spending boom.

As growth slowed and government revenues did not keep pace with spending, the fiscal deficit threatened to breach the target. With government savings falling, and private savings also shrinking, the CAD–which is the investment that cannot be financed by domestic savings and has to be financed from abroad–also widened.

It is nobody’s case that there should be a cut in social spending. The way out lies in shifting national spending from consumption to investment, removing the bottlenecks to investment and growth, and job creation

The overall expenditure (Plan and Non-Plan) on social services sector increased from 14.77 per cent in 2007-08 to 17.39 per cent in 2012-13 (as per Budget estimate). It was at an all time high of 18 per cent in 2010-11 and has been declining since then. But the expenditure on rural development sector, which is a component of social sectors, has decreased to 2.74 per cent in 2012-13 from 2.80 per cent in 2007-08. It was at an all time high of 4.56 per cent in 2008-09 and has been declining since then.

The spending on health and family welfare, meanwhile, has been stagnant. The expenditure on it was 2.05 per cent in 2007-08 and increased very marginally to 2.06 in 2012-13. It was at an all time high of 2.09 per cent in 2008-09. Since then it has been decreasing.

Financing the welfare state is not only a question of taxation but also of what types of taxes and how they are structured. Globally, governments have all the time been attentive to side effects of economic growth and they have chosen types of taxes that minimise or eliminate any damage to growth and which – compared to private market countries – are more pro-growth. European high-budget countries do not have higher average rates of taxation on capital income, not risking capital flight, and they have been cautious about double taxation of dividends. They have relied on income taxes and consumption taxes, including tax on addiction goods.

There is a growing understanding that both high economic growth and effectively functioning welfare schemes are central to the agenda of inclusive economic growth. High economic growth both pulls up people from below the poverty line and generates additional resources for financing welfare schemes and thus provides social protection. Welfare schemes, in turn protect the poor and disadvantaged and equip the labor force in the lower rungs of the skill/economic welfare totem pole to better participate in the process of accelerating economic growth. (Welfare Schemes and Social Protection in India; Raghbendra Jha; ASARC Working Paper 2013/10; Arndt–Corden Dept of Economics; Australian National University)

There is a rethinking in many European nations too. “The classical welfare state is slowly but surely evolving into a ‘participation society”, said the newly coronated king of the Netherlands, Willem-Alexander, last year. By this he meant that the public systems should start encouraging self-reliance over government dependency. It is important to make growth inclusive. The best way to achieve this is through augmentation of human capabilities for participation in the growth process, and improved delivery of public/social services.

It is nobody’s case that there should be a cut in social spending. The way out lies in shifting national spending from consumption to investment, removing the bottlenecks to investment, growth, and job creation, in part through structural reforms, combating inflation both through monetary and supply-side measures, reducing the costs for borrowers of raising financing, and increasing the opportunities for savers to get strong real investment returns. In practical terms for government policy, this translates into containing the fiscal deficit especially by shrinking wasteful and distortionary subsidies.

The reform agenda cannot be slowed down if we want to continue on our desired path of inclusive growth and maintain social spending. Many of the following steps are known and oft repeated; some others may require further thinking. But, giving up on reforms is not the answer.

  • There is need to reduce impediments to investment such as delays in getting permissions, clarifying difficult and non-transparent processes for land acquisition, and increasing access to good infrastructure such as power and roads.
  • Rework the regulatory and incentive structure that keeps small businesses tiny and prevents them from creating good productive jobs.
  • Reduce barriers to entry in various areas of business and allowing FDI, even while ensuring domestic companies are not disadvantaged.
  • Provide incentives and means for the farmer to increase production, even while improving the management and the logistics of food procurement and distribution.
  • Continuing financial sector reform to increase the entry of new institutions, reduce transactions costs for investors, increase access for borrowers and savers to one another, and improve the quality of regulation.
  • Schemes like the MGNREGA should move towards more production – and growth – generating activities.
  • Greater effort is needed in two areas of human development – health and education.

The bottom line: India needs to balance the dual imperatives of growth and inclusion. This can happen only if growth leads to higher and better jobs, and more revenues. There is also need to address delivery-related issues in a mission mode to ensure optimum utilization of funds and to convert outlays into outcomes. For this, good governance is critical.

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