Mumbai: Milton Friedman once described the problem of government budgets with caustic wit. The legendary economist said that there are four ways to spend money and each variant of spending has a different implication.
First, when you spend your money on yourself you do your best to put the money to good use.
Second, when you spend your money on somebody else you try to control costs.
Third, when you spend someone else’s money on yourself you try to have a good time without bothering about costs.
Graphic: Ahmed Raza Khan / Mint
Fourth, when you spend someone else’s money on somebody else—and then you do not care about either the efficiency of spending or the price.
“And that’s government,” said Friedman. Touché.
The deep-rooted temptation to spend taxpayer money carelessly makes sense once you apply Friedman’s insight to the issue.
Government spending outpaced the rest of the economy in the first six decades of the Indian republic, partly because the colonial state was replaced by the development state and partly because competing special interest groups had to be mollified with subsidies and other entitlements.
The result: the government budget ballooned and converted a financial statement into a national obsession.
Here are some numbers. Finance minister John Mathai had estimated total revenue of Rs347.50 crore and total expenditure of Rs338.88 crore in 1950-51, leaving a budget surplus of Rs9.62 crore. Finance minister Pranab Mukherjee had in July budgeted for a revenue of Rs6,19,842 crore and expenditure of Rs10,20,838 crore, leaving a fiscal deficit or borrowing requirement of Rs4,00,996 crore.
Let’s work the numbers. Government spending grew 3 percentage points a year faster than India’s gross domestic product at current prices, going by compounded annual growth rates over 59 years. The absolute numbers are truly astonishing: The size of the economy grew 578 times since 1950 while the size of the government’s spending bill grew 3,020 times.
There are good reasons why a government needs to spend money: to help defend national borders, run the administration, build important infrastructure, support the poor and step in when weak private demand for goods and services hurts economic growth.
But make no mistake: Governments also spend to buy votes, bankroll political machines and placate powerful interests.
There are limits to government spending: It cannot exceed tax and other revenues plus a modest amount of borrowing. The Indian state has often forgotten this simple rule in recent decades, thus flirting with danger.
Take a look at the accompanying chart. The ratio of government spending to gross domestic product since 1970-71 has hovered between 13.08% (in 1970-71) and 22.18% (in 1986-87). This number was highest in the late 1980s, when huge deficits pushed the economy towards the crisis of 1991.
The sheer size of spending is undoubtedly important to all those who worry about economic stability. But there is the additional problem that governments have been more eager to spend on current items such as wages, subsidies and interest payments rather than on capital expenditure to build capacity for future growth. Current needs overpower future goals.
Why? Just go back to Friedman’s insight about why spending somebody else’s money on somebody else is a mug’s game.