India must adopt new policies that reduce poverty by enhancing individual productivity
India’s growth rate nearly doubled from 2003 through 2010, climbing to approximately 8.5% per year. The rising economic tide worldwide lifted all boats, including India’s. The global financial crisis then took its toll, leaving the country with its pre-2003 annual growth rate of about 5.5%. Predictions for India’s 2013–14 fiscal year foresaw approximately 5% growth. If that comes to pass, the average growth rate for the past three years will be the second lowest since the country initiated economic reforms in 1991.
Many government officials and pundits see such changes as evidence that India’s fortunes and misfortunes are due to external factors—factors beyond the control of policymakers. But this is not so. In fact, what weighs most on India’s economy is within its ability to change.
Welfare in India
Regardless of a country’s level of economic development or per capita income, it must be concerned with its poor. Although many policymakers and taxpayers see this as strictly an ethical question, it is an economic one as well, for the fiscal growth of a country depends heavily on the productivity of its population. Helping the poor out of poverty is a win-win proposition for any country, rich or poor.
Although welfare policies share the same fundamental goal—to provide a minimum level of income support to those who need it—there are generally two broad approaches to reducing poverty.
The first approach is an indirect method commonly known as trickle-down growth. This philosophy has as its premise the belief that if economic growth occurs and it is broad-based, then all sections of the population will benefit, and perhaps the poor will benefit at a relatively faster pace.
Because the development of an economy is inherently unequal, however, it is possible that the incomes of the poor will increase at a rate that is below average. This uncertainty is the motivation for the direct approach to poverty reduction: subsidies.
Subsidies are at the heart of the Indian welfare system; however, there are several problems with the policies in place. First, they have generated exorbitant leakage and therefore do not benefit the poor nearly as much as intended. As early as 1985, prime minister Rajiv Gandhi noted that less than 15% of the allocations meant for the poor reached them, a statement that reflected the track record of the public distribution system (PDS) of foodgrains. The situation hasn’t improved since then. In fact, it has gotten worse.
For the 2012–13 fiscal year, almost half of the foodgrains (approximately 25 million tonnes) purchased by the government were “misplaced" en route from warehouses to ration shops. In addition, about 30% of the foodgrains (15 million tonnes) were left to rot in government storage facilities. So in all, four-fifths of the foodgrains never reached the ration shops. The poor received less than 10% of the food that the government procured in their name.
Second, the welfare policies have not changed the nature of the subsidies since the mid-1970s. Fertilizer subsidies are an example. For the government to support the lofty goals of the foodgrains programme, it needed farmers to produce a surplus. Growing more grain required more fertilizer, however, so the government made provisions for farmers to receive fertilizer subsidies. These subsidies are still in effect despite improvements in technology and productivity.
Third, the policies have expanded subsidies beyond what is needed or reasonable. In 2013, the United Progressive Alliance (UPA) government passed the National Food Security Act, also known as the Right to Food Act, which provides foodgrains to approximately two-thirds of the population. All countries have faced the problem of helping the poor, yet not one has made food a constitutional right. Additionally, no country considers two-thirds of its population poor—not even India.
According to the poverty line established by the Tendulkar committee, 22% of the population, or 250 million individuals, were poor in 2011–2012. If the committee had not raised the threshold but had used the previous standard, Dandekar-Rath, less than 9% would have been deemed poor. This is not to suggest that the poverty line should have been kept the same but to show that by both measures, poverty in India is considerably less than two-thirds of the population.
Direct transfers to alleviate poverty amounted to ₹ 2.6 trillion in 2011–2012 (food subsidies, National Rural Employment Guarantee Act, fuel and fertilizer subsidies). Poverty declined by 8 percentage points between 2009–2010 and 2011–2012, and about half of this reduction is the maximum that can be attributed to government subsidies; the other half is contributed by economic growth. About 190 million individuals escaped from poverty between 2009–2010 and 2011–2012; or about 48 million became non-poor due to subsidy expenditures alone in each of the two years. Thus, the government spent ( ₹ 2.6 trillion/48 million) or ₹ 54,000 a year to bring one person out of poverty. To assess that expense, consider the following. For the 2011–12 fiscal year, the average per capita expenditure of the poor was ₹ 708 per month, and the poverty line was ₹ 847. That’s a difference of ₹ 139 a month or ₹ 1,668 annually. In other words, with perfect targeting, only ₹ 1,668 transfer expenditure is needed to make an average poor person non-poor. The government spends ₹ 54,000 per person, or 33 times that which is needed. Admittedly and obviously, perfect targeting is impossible, but it does provide a benchmark by which to evaluate poverty-reduction policies. So let’s take this a step further. According to the Tendulkar poverty scale, there were approximately 250 million poor Indians in the 2011–12 fiscal year. At a cost of ₹ 1,668 per person per year, realizing zero poverty would require an annual expenditure of less than ₹ 42,000 crore, which is less than 0.5% of gross domestic product (GDP). The cost of recent subsidies has averaged about 3% of GDP.
Clearly, it is time to dismantle the current welfare system and adopt new approaches in order to reduce poverty and boost the country’s growth rate.
Rethinking the system
Although many problems plague India’s current welfare programme, the root cause is that government policies have generally focused on bad dole-based subsidies: those that transfer income at a point in time and reduce it only on a “maintenance" basis. It would be far more effective to implement policies that focus on good subsidies: those that enhance individual productivity. Roads, healthcare, and education fall into the latter category, as do clean water and sanitation.
There is an alternative economic and political view of India’s troubles over the past 66 years, and the past 10 years in particular. This view holds that poverty, hunger, and malnutrition are problems for which the recommended policies are not only imperfect, but wrong. What ails the nation, and particularly the poor, are the waste of available food, bad water, and a lack of sanitation. (The unfortunate Bihar midday meal deaths of schoolchildren in the summer of 2013, for example, were caused not by a lack of food but by poor sanitation.) Research over the past decade has documented that an important explanation—if not the explanation—for malnutrition in India is the absence of proper sanitation (for example, drainage and toilets). Given that the top half of the population already has clean water and sanitation, subsidizing projects that expand their availability would almost exclusively benefit the poor.
Food subsidies are key to many countries’ welfare systems, and India would do well to examine those models and reform an inefficient system that has the government (through the Food Corp. of India) procuring foodgrains from farmers at a price that the government sets, storing the food in government silos, and distributing it to ration shops.
It would be a lot simpler, and considerably more liberal, if the government delivered food stamps to the poor. Food stamps give the recipient the freedom to choose what to buy and where to buy it. Whether the recipient purchases bread or broccoli should not be the concern of the government. Other countries have faced this problem and have found that the solution is to give the recipient maximum freedom.
Food stamps are not the only alternative, though. Cash transfers and conditional cash transfer are also options. Despite other countries’ adoption of these systems, however, India’s policymakers continue to debate the merits of such schemes because powerful interest groups are opposed to new methods.
The government should go further still and move towards a system where states have greater responsibilities toward the formulation and implementation of welfare policies. All central government expenditures on welfare should be allocated as part of the Finance Commission’s grants, and the states would be free to implement their own food subsidies, fertilizer grants, employment programmes, and labour laws.
India’s welfare system requires a new vision. It is critical for India’s new administration to carefully examine the efficacy of the country’s current policies and create new ones that reduce poverty by enhancing individual productivity. Making the system more effective will not only help people out of poverty but also boost the country’s economic growth.
It is important to remember that prior to the UPA government, partial reform was on its way. The employment guarantee schemes cost less than half of the current National Rural Employment Guarantee Act, and many government officials had recognized that PDS was unworkable. PDS cannot be disbanded immediately, but certainly a three-year timeframe is feasible. Then the poor—and all Indians—can look forward to a better economic situation for themselves and their country. For this to happen, however, the new administration must make a new welfare system one of its first priorities.
Surjit S. Bhalla is chairman of Oxus Investments, an emerging market advisory firm, and a senior advisor to Zyfin, a financial information company.