Are freebies affecting the economic growth of India?

There are subsidies that are productive and then there are those that are wasteful

April 29, 2022 12:15 am | Updated 06:03 pm IST

In an address delivered at the Delhi School of Economics last week, N.K. Singh, the chairperson of the 15th Finance Commission, warned about how the race to provide freebies to voters could be a “quick path to fiscal disaster”. He also noted that freebies could be harmful for the long-term economic growth of the country and emphasised the need to distinguish between productive and unproductive forms of welfare spending. In a conversation moderated by Prashanth Perumal, Renu Kohli and Himanshu examine whether there is a case for doing away with freebie culture. Edited excerpts:

Is there a trend of deterioration in the financial situation of States? Are freebies the reason for it?

Renu Kohli: When the argument is framed as freebies versus fiscal stability, a binary answer is often not possible. So let me just clarify that there are different kinds of freebies. Some of them are extremely justifiable, some of them are not. As far as fiscal stability and financial deterioration is concerned, if we see the welfare spending of the States, and if it is sustainable and affordable, then that is fine as it is the prerogative of the political executive. Having said that, we must understand what exactly we mean by fiscal stability. Broadly speaking, in common parlance, fiscal stability is a situation in which the government is able to deploy its fiscal policy towards long-term economic objectives, which are high employment and growth rates. That leads us to measures of fiscal stability. If you see the study of the State finances conducted by the Reserve Bank of India, you find that from 2005 onwards, in aggregate, States have adhered to the limit in terms of their gross fiscal deficit, which is the gap between the total revenue of the State and the total expenditure.

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The mandate is under the ceiling of the fiscal responsibility legislation, 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 crisis year and 2015-16 and 2016-17 were years of power sector reforms in which power sector debt was taken over by the state governments. Secondly, what is the trajectory of the outstanding debt? Outstanding debt reduction has actually progressed quite well in the case of the States. From a high of 31% of GDP, it came down by almost 10 percentage points to about 22% of GDP by 2014-15. After that, it has inched up about five percentage points by FY 2020. If we compare this with the Central government’s track record, the Central government has never been able to adhere to fiscal deficit limits. Secondly, when it comes to debt reduction, the Central government’s debt-to-GDP limit is supposed to be 40%, but it has now crossed 90% of GDP. So, the problem of fiscal stability is more pressing at the level of the Centre.

Himanshu: We need to look at the definition of freebies itself. The term “freebies” gives you an impression of something that is a dole or a gift given to the population. But then freebies can be of different varieties. Certain kinds of expenditure that are done under populist pressures or with elections in mind may be questionable. But given that in the last 30 years there has been rising inequality and also some level of distress in the last decade, some kind of relief to the population in the form of subsidies may not be unjustified. It may actually be necessary for the economy to continue on its growth path. On the fiscal front, given that after 2017, when we have the goods and services tax (GST) which is more or less taking away the power of the States to generate revenues and given that responsibility for the majority of the welfare expenditure lies in the domain of the States, the hands of the States are squeezed. So, fiscal stability is not just about expenditure but also about revenues. And mind you, the Centre also engages in giving out freebies not just to the poor people but also to a large number of corporations.

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

Himanshu: We don't have official poverty estimates after 2011-12. The only estimates that we have are from a number of independent studies by private researchers. And I completely disagree with N.K. Singh’s claim that the rate of poverty reduction has doubled under the Modi government. None of the studies, including the IMF study, the World Bank study, or consumption surveys, confirm that. In fact, there is at least one study that concludes that the rate of poverty reduction has slowed down under the Modi government. There is also a consensus that the 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 programmes has definitely contributed to poverty reduction. This does not mean that growth does not have a role to play in reducing poverty. If the growth during the Modi years was as good as it was before that, then probably the rate of poverty reduction may have been higher. So, I don't think this is a question of welfare versus growth. I'm a little hesitant to call welfare measures as freebies because they may be essential not just for poverty reduction but also for growth. Remember, we are in a slowdown simply because demand in the economy overall has collapsed. And I think welfare spending has been able to at least prevent consumption demand from falling any further.

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Renu Kohli: The very idea of estimating poverty on the basis of private final consumption on the basis of national accounts was rejected long ago. So, estimating poverty on this basis is simply unacceptable. There has also been no consumption expenditure survey. We have to question estimates of poverty 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 formalisation has increased, there's no basis to believe that income distribution has not worsened as an outcome of formalisation. Secondly, at a time when free food is being given, where is the proof that the underlying income of the poor has remained intact in the absence of any consumer expenditure survey? There's no way that this can be established. Also, the fact that the latest survey was junked and has never been published creates the suspicion that poverty may have risen.

What proportion of spending by States is productive rather than aimed simply at gaining votes in elections? 

Himanshu: Well, in a democracy where political parties try and get votes from every section of the population, there is obviously a tendency for State governments to try and provide some kind of relief to voters. I am certainly in favour of expanding, for example, the MGNREGA type of spending and subsidy 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 doles. They build a healthier and a stronger workforce, which is a necessary part of any growth strategy. That is similar to a State spending on education or health. One can call these as an investment for the long-term, for improving the productive capacity of the population. But yes, there are obviously cases where State governments have gone astray and have gone into providing all sorts of freebies or gifts. But when it comes to simply giving away loan waivers, I am not in favour of these because they have undesired consequences such as destroying the whole credit culture and it blurs the very basic question as to why is it that a large majority of the farming community is getting into a debt trap repeatedly.

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We need to be talking about some of these issues in the larger context of whether they actually contribute to growth. Do they actually contribute to poverty reduction, or are these simply being done to get short-term benefits at the cost of long-term damage? We know about free electricity that is being given in various States to the rural communities which has sometimes led to disastrous consequences in terms of declining water table, wastage of electricity and various other things. There are nuances to the issue, and one will have to get into those nuances to take a final call on whether a certain welfare spending is necessary or not. Lastly, some people have been questioning subsidies going into education, such as for laptops and other things. Some of them have now become necessities for increasing productivity, knowledge, skills, and various other things. So, we need a more nuanced understanding of the issue.

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Renu Kohli: There is absolutely no justification for promising 200, 300 or whatever number of units of power to middle class or urban populations who are by and large regular income earners. I have a slightly different perspective on loan waivers in the light of agriculture being a very costly and extremely risky venture. It's one of the riskiest activities to undertake compared to, say, manufacturing or any of the services 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 kind of extraordinary shock. Now, we can talk about loan waivers in the light of weather and other risks and also the fact that crop insurance has by and large always failed to offset shocks in agriculture. Also, we are in a position where direct benefits transfer can be used to deliver loan waivers directly to distressed farmers and the cost of the waiver is immediately taken on the government’s budget and financial intermediaries are not involved. Secondly, the tendency towards unproductive spending is not more pronounced at the level of the States as compared to the Centre. If we look at social sector expenditure, there is a rising trend at the level of the States, but then the rising trend at the level of the Centre is extraordinarily high. And if you look at the core sector schemes, then the revenue spending component is as high as 65-68%. So almost two-third of the expenditure is revenue expenditure. The issue of unproductive and productive spending should be looked at in this light and in the light of mounting interest payments.

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