In an essay published in January, economist Alex Tabarrok pointed out that nearly two-thirds of the $2.2 trillion US federal budget is spent on what he described as welfare and warfare programmes. Very little money is budgeted to support innovation that is needed to restore economic vitality of that country.
For example, a look at budget documents shows that the Indian government has spent Rs 9.12 trillion on various subsidies in the nine years since fiscal year 2004, and this number would be far larger if the current value of money is considered. It is well known that most of these subsidies help people who are relatively better off, rather than the genuinely poor, be they rich farmers who use fertilizers or car owners who burn subsidized fuel.
Another example is the flagship Mahatma Gandhi National Rural Employment Guarantee Scheme, which has seen a cumulative spending of Rs 1.66 trillion. The scheme aims to help the rural poor, and has proved to be a useful income support mechanism for poor families. But no lasting capital assets have been created, so it is worth asking whether the money would have been more effectively used if it had been used to fund, say, rural roads.
Economists like to think in terms of opportunity costs, or what is being given up to pursue a particular activity. So the opportunity cost of resigning your job to study further is not just the cost of college, but the salary you are giving up to get higher education.
I asked a few experts about what could have been done with the money that the government has spent on subsidies over the past decade. Building a kilometre (km) of good rural roads costs about Rs 5 crore per km, which means that India has effectively given up around 20,000km of new rural roads, assuming one-tenth of the subsidy spending since 2004 had been diverted for this work.
Or consider the pet project of former president A.P.J. Abdul Kalam, for the provision of urban amenities in rural areas (Pura), that has now been taken up by the government. The plan is to create rural hubs with good infrastructure that will help regenerate local economies. In an interview with The Economic Times in February, Srijan Pal Singh, an associate of Kalam, said that each Pura hub would require an investment of Rs 60 crore over seven years. “The size of a Pura can vary from 10 to 50 villages. India has six lakh villages and we will need approximately 7,000 Puras to cover them,” he said. That, by the way, would be a total bill of Rs 420,000 crore—once again less than half of the decadal subsidy bill.
One can offer similar examples in education, public health and water. None of this means that only physical capital matters; the money could also have been used to improve human capital by spending more on the battle against malnutrition or improving skill levels. More money could also have been diverted towards structural challenges such as renewable energy or a second green revolution.
The political economy of subsidies draws its strength from a fractured society that cannot agree on the provision of public goods that can help all Indians. The focus is on grabbing money for sectional interests. This problem is present in most complex societies, as the economist Mancur Olson showed many years ago. But the problem is particularly rampant in India, with its complicated matrix of caste, religion and language.
The waste of financial resources in the pursuit of myopic political goals is not evident at any one point of time, when calls to protect consumers against higher oil prices or offer doles to the rural poor have a resonance. But the picture changes when a longer-term view is taken. The inability of the Indian political system—and indeed Indian society as well—to create assets that help income growth on a sustainable basis becomes evident.
Here is what Tabarrok wrote at the end of his essay: “Our economy is stagnant and for the first time in a long time, and the national mood is deeply pessimistic. To restore our economy and our spirits we need to become an innovation nation. An innovative nation would improve the prospects for economic growth but could do much more. The warfare-welfare state divides the pie and also divides Americans. Americans, however, are an innovative, forward-thinking people and the prospects are good for uniting them on a pro-growth, pro-innovation agenda.”
Seems familiar?
Niranjan Rajadhyaksha is executive editor of Mint. Your comments are welcome at cafeeconomics@livemint.com
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