The political economy cycle in India
As a democracy matures, citizens become more willing to trust elected representatives to plan and take steps for the long-term growth and development
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One common complaint during this election has been that the election commission (EC) has to be consulted before the government and its regulatory agencies take any routine decision. Decisions relating to gas price hikes and bank licences all had to be cleared by the EC, whose over reach poses a threat to the economy, goes the complaint. However, a Mint report this week showed that the economy slows down anyway before the polls while government intervention is opportunistic just ahead of elections.
The analysis of key economic variables over the past three decades suggested that new project additions dry up each time there is a Lok Sabha poll, as businessmen turn cautious and wait to gauge what the future policy environment will look like. Industrial credit dries up as a result, and consumption of key materials such as steel and cement falls.
Policy uncertainty may not be the only reason for the decline in consumption of raw materials such as steel and cement though. Cement consumption declines ahead of elections as builders divert funds to illicitly fund political campaigns, research by economist Devesh Kapur and political scientist Milan Vaishnav shows.
Government spending (and the fiscal deficit) goes up in an average election year, which tends to fuel inflation rather than spur growth, suggesting that the extra public expenditure ahead of polls is often wasteful.
A recent analysis of the Union government’s budget documents by Deepa S.Vaidya and K. Kangasabapathy of the Economic and Political Weekly Research Foundation shows that the extent of ‘fiscal manipulation’ shoots up sharply ahead of parliamentary polls. The duo analyze the discrepancy between the budget estimates of revenue and expenditure numbers and the revised estimates (and actual) since 1991 to find that the revenue receipts tend to be overestimated and total expenditure underestimated in almost all budget years. In other words, there is a regular tendency to understate deficit numbers. But in interim budgets, the deviations are much larger and sharper, the duo found.
“This suggests that finance ministers could be using manipulative strategies while presenting interim budgets, perhaps to gain some political mileage,” wrote Vaidya and Kangasabapathy. “In the interim budgets, the revised estimates place the borrowings and other liabilities at as high as nearly 46% over the budget estimates, due to which revenue and fiscal deficits soar by nearly 77% and 46%, respectively, compared to 11.9% and 7.9% in regular budgets.”
Although India’s interim budget this year appears to be an exception to the earlier trend of increased government borrowing in an election year, even this year the actual numbers may disappoint.
“P. Chidambaram’s budget, his only interim budget in the last 25 years, seems to be an exception compared to the five interim budgets analysed,” wrote Vaidya and Kangasabapath in the afore-mentioned paper. “While this may be due to his specific focus on fiscal consolidation, the subsequent fiscal performance figures available up to January 2014 along with some of the adjustments he made to achieve fiscal consolidation suggest that the actuals for 2013-14 when available may not be as rosy as the revised estimate figures Chidambaram presented. Furthermore, such adjustments might also pass on a large burden to the budget estimate for the regular budget of 2014-15, due after the elections.”
In many developing nations the fiscal deficit spikes up during an election year, studies show. “The overall fiscal deficit ratio (in low income countries) increases by about 1 percentage point of GDP during the election year, and this is mainly driven by the observed increase in government current spending,” wrote Christian Ebeke and Dilan Ölçer in a 2013 International Monetary Fund working paper . “In the post-election years, there is certainly an attempt to rebuild the eroded fiscal buffers, but it does not appear large and balanced enough to generate any significant statistical impact.”
Ever since the economist William Nordhaus first wrote about the political business cycle, a growing body of evidence has validated his hypothesis about opportunistic behavior by governments, keeping the election in mind. In its simplest form, the theory suggests that an elected government will conserve resources during the initial phase of its term only to splurge just ahead of elections.
Over the years, several researchers have noted that governments may not necessarily step up overall spending ahead of elections but may direct additional spending towards special interest groups. In India, that is what seems to hold true for state governments, which are usually far more resource-constrained than the Union government. Analyzing data for 14 Indian states between 1960 and 1996, World Bank researcher Stuti Khemani found little evidence of fiscal profligacy in an election year. But Khemani found evidence of manipulation of fiscal instruments to target narrow interest groups, such that there is no effect on the overall fiscal deficit number.
“In election years in the Indian states, there is evidence of small manipulations of fiscal instruments to target benefits to narrow interest groups, such that there is no net effect on the overall fiscal deficit,” wrote Khemani in a 2004 paper . “Tax collection from specific producer groups is lower and public investment spending is higher, while spending on what are generally regarded as more populist categories is lower.”
Government intervention in countries such as India may also take the form of manipulating the interventions of state-run enterprises, such as the public sector banks. The amount of farm loans given by state-owned banks was 5-10 percentage points higher in election years than in years following an election, a 2008 research paper by Harvard University economist Shawn Cole found.
“In election years, more loans are made to districts in which the ruling state party had a narrow margin of victory (or a narrow loss) in the previous election. This targeting does not occur in non-election years,” Cole wrote. “Politically motivated loans are costly: they are less likely to be repaid, and election year credit booms do not measurably affect agricultural output.”
One of the most interesting research papers on electoral cycles that I read recently is a February 2014 study by political scientists Brian Min and Miriam Golden. Using data from the power corporation of Uttar Pradesh, India’s most populous state, Min and Golden showed that electricity line losses tended to spike up just ahead of state assembly elections, as political parties deliberately redirected power to unbilled users. “Political factors appear to affect line losses in ways that technical and economic factors alone cannot explain,” the duo wrote .
A recent research paper by economists Megan Sheahan and Christopher B. Barrett of Cornell University, Yanyan Liu of the International Food Policy Research Institute and Sudha Narayan of the Indira Gandhi Institute of Development Research highlights the importance of political personalities in determining whether government funds are directed where they are needed or are abused to build patronage networks.
The authors study allocations in sub-districts of Andhra Pradesh under the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) and find little evidence of patronage effects before 2009: neither swing localities nor support bases of the ruling party (Congress) received disproportionately higher funds. But the trend changed after the 2009 elections, and in subsequent years the scheme was used as a tool for patronage.
“…evidence of widespread patronage in the post-election years is best understood within the changing political climate immediately after the 2009 election,” wrote Sheahan, Liu, Barrett and Narayanan. “Recall that YSR, the figurehead of MGNREGS in AP, was killed not long after his re-election and that a struggle for power in the following years ensued. Evidence of patronage during this time suggests that this disorder prompted politicians to use MGNREGS funds to secure their place in the AP political hierarchy moving forward, grounded in how their constituents voted in the most recent election.”
Is there an institutional fix to the problem of political opportunism in government spending? There does not seem to be any easy solution but political scientists argue that as a democracy matures, citizens become more willing to trust elected representatives to plan and take steps for the long-term growth and development. Short-term transactional politics to please or appease special interests then assume less importance, and politicians become more willing to address broader concerns. Perhaps Indian democracy is still a work in progress in that respect.
While the level of democracy in a single year has no measurable impact on economic growth in the subsequent year, its democratic experience over a long stretch of time is positively associated with growth in subsequent years, wrote political scientists John Gerring, Philip Bond, William Barndt and Carola Moreno in a 2005 research paper . Over a long horizon democracy delivers superior growth performance, the authors argue.