Electricity or schools? Roads or hospitals? Why it’s not easy for Modi to fix ‘gifts’
Jhe “gifts vs. development expenditures” debate reflects an overarching problem that economics is meant to address: the relationship between unlimited wants and limited means that have alternative uses. So, would you sacrifice an electricity subsidy to invest in better schools? Or would you rather build more highways than increase the health budget? This is the question the Prime Minister asked when he said that handouts were going to hinder development.
There are gifts and presents. Education, social benefits and highways all have what economists call positive externalities; that is, they have a public utility that goes beyond the benefit to the individual user. What about free lunches in schools, which the late MG Ramachandran introduced as Chief Minister of Tamil Nadu?
The unintended consequence of this classic free education was that school attendance improved, and with healthier children, the state’s birth rate dropped dramatically. The social gain far exceeded the cost of “free” meals. Similarly, free toilets could improve public health. Same with subsidized cooking gas — it would improve women’s health. But should this be done, for example, to the detriment of the employment guarantee scheme?
The issue is therefore not freeness itself (everyone wants as much as possible), but the constraint imposed by limited means. If a government has the money, it can hand out whatever gifts it wants, as the Arab Emirates have been doing for decades.
The Aam Aadmi party government in Delhi can give free electricity up to a limit of consumption, and also invest in schools because there is no lack of money. But what about Punjab, where the AAP announced free power in a most indebted state in the country? Himachal Pradesh leads Punjab close to debt, and the AAP promises it there too. Each of these choices imposes a cost – another program is blocked or you go into debt.
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IIn advanced economies, these “transfer payments” through social security, unemployment benefits and the like have come to dominate budgets, leaving less and less money for infrastructure, research and other “investments” for growth. This makes the welfare state increasingly unaffordable; in Britain, the National Health Service is close to collapse.
The founder of Singapore, the late Lee Kuan Yew, clearly stated the principle: a government should not spend money in such a way as to leave behind a burden for future generations. He mandated high personal savings with which Singaporeans could purchase government-provided housing, and also mandated personal health funds to pay for medical emergencies. In exchange for people paying their own way, he offered low taxes.
Would it work in a poor country? In India, the Pradhan Mantri Awas Yojana involves a grant, as does the Swasthya Suraksha Yojana. So when does a central grant become superior to a state grant?
Much of Europe also ignored Lee’s approach. High taxes in exchange for a cradle-to-grave welfare program have become the social contract. Lee’s advice was even further ignored after the 2008 financial crisis and then the pandemic. Country after country they freely spent the money they didn’t have, sharply increasing the ratio of public debt to GDP, in some cases up to two or three times GDP.
The resulting tax on the future, through increased interest payments on bloated debt, now haunts many countries, including India – where the debt-to-GDP ratio exceeded 85%, while 60 % was considered desirable. When this debt includes large unpaid electricity subsidies, the prime minister is right to sound the alarm.
Except that state governments have a meter: they face tax pressure mainly because the share of tax revenue the Center gives them has dropped dramatically. Fix that and states will be able to afford their freebies – even those without any externalities.
Blame the voter who invariably chooses the promise of donations today over a vague promise of, say, better schools tomorrow. As they say, take what happens and run! Asking the Supreme Court to issue an edict or asking Parliament to pass a law is not a solution – the Fiscal Responsibility Act, for example, did nothing. Having thrown down the gauntlet, does Narendra Modi have the courage to change this dynamic?
By special arrangement with Business Standard
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