The price of fiscal folly

Borrowing to distribute for consumption is to be guarded against. When — as now — the government has debt outstanding, launching the universal basic income would amount precisely to that.

Updated - January 24, 2017 12:56 am IST

Published - January 24, 2017 12:12 am IST

Illustration: Keshav

Illustration: Keshav

With the annual Budget of the Central government to be presented soon, exhortations have appeared in public on what it should contain. Two of these are somewhat extreme in their implications for the general population. One concerns borrowing by the government while the other amounts to a proposal on how best the government should allocate its expenditure.

In a recent speech made in Gandhinagar, the Governor of the Reserve Bank of India is reported to have cautioned the government against increasing its borrowing. This brought him instant praise from sections of the media including this newspaper. He is reported as stating that “the government should desist from borrowing even more and pre-empting resources from future generations”. Not only did these remarks receive laudatory support in The Hindu but an editorial on January 14 had gone on to speak approvingly of his assertion that “government borrowing tends to crowd out private investment”. There is no unconditional validity to these propositions. This has been known to economists for over three-quarters of a century.

Why government spending pays

It is difficult to make sense of the proposition that government spending by means of borrowing pre-empts resources from future generations. Actually, directly or indirectly, every expenditure will serve as a draught on today’s resources, i.e., labour and capital equipment. This is equally true of public and private expenditure, the only difference being that in the case of the former often it is its very rationale that resources are drawn into production thus pre-empting their remaining idle. But why should this ever amount to pre-empting resources from future generations? Unlike natural capital, these resources are man-made, and expenditure can actually create more of them. Furthermore, these newly-minted resources are inherited by future generations who far from being short-changed are left with more income-earning assets than they would have had were the government to desist from borrowing to spend today. Sure, future generations would have to pay more taxes to retire the government’s debt, but so long as the returns are greater than the interest burden, future generations are unambiguously better off. Are not at least some sections of India better off now that in the 1950s the Government of India had borrowed to build housing for public servants and the Indian Institutes of Technology and Management?

Presumably, it is the possibility of a rise in the interest rate that unleashes the challenge in the form of the argument of crowding out, whereby a rise in public spending raises the interest rate faced by the private sector. But, as the Governor should know, this can be simply and effectively dealt with through monetary policy. ‘Quantitative easing’ in the United States was precisely such a mechanism whereby the central bank ensured that an expansionary fiscal policy following the financial crisis did not result in a rise in the interest rate. Far from government spending via borrowing crowding out private expenditure, it leads to a ‘crowding in’ whereby the demand generated by government spending expands the market for private investors, raising the level of economic activity today and even in the future. Of course, this requires the existence of unemployed resources, which is mostly the case in a large part of the economy. So, the assertion that greater public spending would crowd out private investment is based jointly on a refusal to accept accommodating monetary policy as valid and the assumption that the economy is at full employment.

The universal basic income idea

This takes us to the second of the two proposals for budgeting in India made recently. Away from debt and deficits, in fact quite innocent of them, the case has been made for the provision by government of a universal basic income (UBI). This idea has been floating around the capitals of the western world for a while, and it is not surprising that policy entrepreneurship would ensure its appearance here and its feasibility has been demonstrated, so to speak. Thus the economist Vijay Joshi has in his book, India’s Long Road, proposed that every citizen be given an income transfer equivalent to what is needed to raise those currently deemed poor to above the official poverty line. He shows that this would involve a transfer of ₹3,500 per capita per annum. The virtue of this arrangement, it is claimed, is that it would eliminate poverty and yet leave some over to actually raise public investment.

However, it is an unusual approach to poverty eradication that the non-poor, who in India are the majority and some of whom are rich by international standards, be given the same income as the poorest. It may be imagined that the idea of UBI is based on the social democratic imagination, but the welfarism that it implies is neither socialist nor democratic. It is distinctly at odds with Karl Marx’s vision of a decent society as one which draws from “each according to their abilities (and gives) to each according to their needs”. Enthusiasts of the UBI would need to account for a scheme in which the able-bodied receive as much as the infirm and infants receive as much as their mothers. There appears to be a mismatch between rights and responsibilities here.

The usefulness of the accounting reproduced above is mainly to show us how much subsidies cost in terms of a potential benefit foregone by households. It attains some salience when we recognise that certain subsidies in India are regressive and others do not even entail a transfer, such as when foodgrain rots in the godowns of the Food Corporation of India while getting accounted as food subsidy in the books. For close to thirty years since 1947 the Central government’s subsidy bill had been meagre. It is only recently that it has burgeoned, both in response to vote-bank politics and as political parties compete to showcase their compassion. But the answer to the accumulating subsidy bill lies less in moving to the distribution of its cash equivalent as much as to transferring the potential saving from their elimination into public investment. Not only does public investment have a greater impact on growth than subsidies in their present form but, to return to the issue of inter-generational equity, the capital formation that it entails benefits future generations by enhancing the productive capacity of the economy. And, above all, in our present state of development and given the current state of the public finances, the UBI would leave India bereft of public goods and services. Once everyone has been given a certain amount of income under the auspices of the state, it gets absolved of all responsibility for providing these goods and services which the private sector has no incentive to provide. We would now have to live content with our paltry benefits on islands without the bridges needed to take us to our neighbours.

Importance of public goods

It is entirely understandable that in India the citizen is dismayed by the callous disregard for the use of public monies by the political class. But it would be disastrous to overlook the feature that a significant part of what we require for a dignified and convivial existence are public goods which would have to built by the state. Both a sensible allocation of its revenue and public borrowing by the state are part of this process. To take a lesson from history, during the Second World War the national debt in the U.S. rose sharply to enable the government to engage in combat. The U.S. economy was immediately energised and after the War there followed unparalleled prosperity for the next generation, enabling the government to repay the public debt with ease.

Public borrowing is not necessarily bad but borrowing to distribute for consumption is to be guarded against. As monies are fungible, when, as now, the Government of India has debt outstanding, launching the UBI would amount precisely to that.

But our most important lesson comes from India itself. The idea that the nascent Indian state should showily distribute public revenues in the manner of its erstwhile maharajahs had made the rounds soon after the country gained independence. It is very likely the clamour that had led Jawaharlal Nehru to remark in Parliament, in response to a no-confidence motion against his government, “We have always to choose between benefits accruing today, or tomorrow, or the day after. From the country’s point of view, if we spend the money we now have for some petty immediate benefits, there will not be any permanent benefit.” It seems we have been through the debate on the UBI once already.

Pulapre Balakrishnan is Professor, Ashoka University, Haryana and Senior Fellow, IIM-Kozhikode, Kerala.

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