Home / Opinion / Views /  Let us pause to think about ‘freebies’ versus incentives

Let us digest some numbers. The bottom 50% of India’s population claim 13% of total income, and the middle 40% take another 30%, while the rest goes to the top 10%, of which the top 1% laps up 22%. On wealth, the picture according to the World Inequality Report looks like this. The bottom half has 6% of total wealth, while the middle 40% has 30%. The balance 65% is held by the top 10%, of whom the top 1% have 33%. This is the state of distribution of income and wealth as per the latest data. In such a situation, what is a government supposed to do?

Recent news on the collapse of the Sri Lankan economy has engendered a fresh debate on the state’s role. Its government cut taxes across the board and provided several free goods and services, as a result of which the economy collapsed and the heavily-indebted country has had no choice but to default on its commitments. As a corollary, the issue of freebies given out by Indian states has come under the lens here. The focus is more on states as they’re easy whipping boys.

The argument put forward is that states are habituated to giving freebies, be it in the form of loan waivers or free electricity, cycles, laptops, TV sets and so on. Is this sustainable? If states keep spending money in this fashion for supposed political gains, their finances will go awry and fiscal profligacy would prevail. The last bit may be far-fetched, as the Fiscal Responsibility and Budget Management (FRBM) rules are more binding on states; they can’t borrow beyond their limits and any deviation has to be approved by the Centre and central bank. Therefore, while states have flexibility on how they choose to spend their money, they cannot in ordinary conditions exceed their deficit ceilings. The Centre used an escape clause for its own limit, interestingly, but exercised restraint in its pandemic-relief expenditure.

Let’s try to define freebies. States like Tamil Nadu and Bihar are known for giving women sewing machines, saris and cycles, but they buy these from budget revenues, contributing to the sales of these industries. It can be considered a boost for the supplier industry and not a wasteful expenditure, given the corresponding production. Punjab has been criticized for giving free water and power that helps rich farmers. The contention is that only the rich have access to pump sets that are run free of cost to extract water. Such schemes curry favour with farmers at election time, but it can counter-intuitively be argued that wheat and rice prices would have been higher if those costs were borne. Therefore, this is an incentive to produce at a low cost. It is analogous to support-price driven procurement by the Centre, which is also aimed at farm income support.

Moreover, isn’t the same being done for industry with production-linked incentives (PLIs) which promise businesses around 5% of their turnover for meeting investment and sales criteria? Can we really criticize state hand-outs for ‘rich farmers’ in the form of a subsidy while hailing the same given to ‘rich industry’ as an incentive? This must make us stop and think, as there cannot be double standards for different producers. The difference is terminology. A ‘subsidy’ is looked down upon, while an ‘incentive’ is considered progressive.

Now consider farm loan waivers. When industry defaults and a non-performing asset (NPA) is created, the payout indirectly comes from bank funds, which includes deposits. With no NPAs, depositors could get better returns and borrowers could be charged lower rates, as NPA provisions and write-offs raise the cost of intermediation. Farm loan waivers involve payments made to lenders from state budgets. Here too, one cannot accept one and reject the other, as both sectors work under risk and uncertainty.

The budget objective of a government is to bring about redistribution and provide incentives in the right areas, so that growth is kept ticking and inflation is held in check. Fertilizer subsidies also ensure that food prices are kept under some control.

Redistribution is again worthy of debate. Most so-called freebies are given by the Centre rather than the states. For example, the PM Kisan scheme assures cash transfers to farmers and costs the exchequer about 65,000 crore. The rural job guarantee programme has historically been a Keynesian type of a scheme, analogous to ‘digging up holes to fill them up’, where not much productive work is accomplished but workers are paid wages. Here too, the government may be spending between 60,000 crore and 1 trillion (during the pandemic). Can we really object to such outlays, given that Indian inequality remains so stark and has not been addressed by the much talked-about ‘trickle-down theory’ of growth?

The Rawlsian theory of justice is applicable here for sure, given our income and wealth disparities. The classic principle of greatest benefit to the most disadvantaged needs to be invoked for government expenditure, especially now that it’s clear that the prevailing system does not let weaker sections escape their circumstances. It is true that states will have to handle their finances better and a line needs to be drawn on hand-outs. States tend to cut back on capital expenditure once they approach their FRBM limits.

Ideally, a proportion of state expenditure should be earmarked for so-called freebies. This would ensure better overall utilization of resources. But the term ‘freebies’ should also be defined better so as to distinguish cash transfers from ‘free gifts’, as the latter can act as a direct boost to supplier industries. A fair assessment of these would serve India well.

These are the author’s personal views.

Madan Sabnavis is chief economist, Bank of Baroda and author of Lockdown of Economic destruction


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