What a Nobel laureate can teach us about the economics of electoral bonds

These issues concern a well-known problem in economics and finance – the asymmetry of information. Its consequences are loss of welfare and market failure.

Using the example of the market for second-hand cars, an economist showed back in 1970 how information asymmetries between sellers and buyers about the product’s quality can cause market failures. The economist in question is George Akerlof, a Nobel Prize-winning American economist, and husband of former US Fed chair and US Treasury Secretary, Janet Yellen.

The market for political finance is, of course, more complex than that for used cars. Before electoral bonds were introduced in 2017, political parties were required to disclose the identity of any donor that gave them more than Rs. 20,000, a condition they side-stepped by accepting the bulk of donations in smaller sums.

Electoral bonds carry no such condition. Political parties can accept unlimited sums through these bonds without disclosing the donors’ identities. The bonds are interest-free bearer instruments issued in multiple denominations of up to ₹10 million. They can be bought by individuals or companies via cheques or digital payments from the State Bank of India. The buyer can donate the bonds to any political party that has received at least 1% of the vote share in the previous Lok Sabha or a state assembly elections.

Although neither the donor nor the political party have to disclose the donor’s identity, as the Supreme Court said, the government of the day can easily find out their identities. The political party in office thus enjoys access to information that its political adversaries don’t, giving rise to the scope for “retribution", as the CJI said.

This is a consequence of the asymmetry of information between the seller (the political party in office) and the buyer (the donor). What consequences other than retribution are to be expected from this?

Of the total money raised through electoral bonds between March 2018 and July 2019, the highest denomination accounted for more than 90%. Campaign finance of this scale cannot come from small donors; It’s likely coming – directly or indirectly – from high-net-worth individuals and corporates.

It’s naïve to expect that a business tycoon, with an eye on the company’s stock price and profit margins, will simply write a political party a cheque out of gratitude for good governance and policies, without negotiating clear pay-offs.

Political funding and corporate lobbying go hand in hand in every country, giving rise to quid-pro-quo, favouritism, bending of rules, abuse of power, and tailor-made policies that give donors an edge over competitors. This disrupts the level playing field, leading to loss of welfare for citizens, crony capitalism, bribery, corruption and money laundering. In the worst-case scenario, political donations may cease to be voluntary and become extortionary.

It would also be naïve to expect that India could be an exception when it comes to the market for political funding. Hence, there is a need for a high-quality electoral funding system with high degree of transparency and accountability, and no information asymmetries.

Political funding has deep, complicated links with the economy. Elections are an expensive business and are becoming more so every year. Political parties spent nearly twice as much on the Lok Sabha elections in 2019 as they did for the 2014 elections, and more than what was spent in the US presidential election in 2016.

Economists such as Akerof may have a tip or two on how markets for political finance can be made to function better.