Insights into Editorial: Are freebies affecting the economic growth of India? – INSIGHTSIAS

 

Context:

In an address delivered at the Delhi School of Economics, N.K. Singh, the chairperson of the 15th Finance Commission, warned about how the race to provide freebies to voters could be a “quick path to fiscal disaster”.

He also noted that freebies could be harmful for the long-term economic growth of the country and emphasised the need to distinguish between productive and unproductive forms of welfare spending.

 

Need to look at the definition of freebies itself:

1. The term “freebies” gives you an impression of something that is a dole or a gift given to the population.
2. Political parties promise to offer free electricity/water supply, monthly allowance to unemployed, daily wage workers and women as well as gadgets like laptops, smartphones etc. in order to secure the vote of the people.
3. The states have become habituated to giving freebies, be it in the form of loan waivers or free electricity, cycles, laptops, TV sets and so on.
4. Certain kinds of expenditure that are done under populist pressures or with elections in mind may be questionable.
5. But given that in the last 30 years there has been rising inequality, some kind of relief to the population in the form of subsidies may not be unjustified but actually necessary for the economy to continue on its growth path.

 

Is there a trend of deterioration in the financial situation of States? Are freebies the reason for it?

When the argument is framed as freebies versus fiscal stability, a binary answer is often not possible.

Some of them are extremely justifiable, some of them are not. As far as fiscal stability and financial deterioration is concerned, if we see the welfare spending of the States, and if it is sustainable and affordable, then that is fine as it is the prerogative of the political executive.

 

Freebies versus Fiscal stability:

We must understand what exactly we mean by fiscal stability.

1. Broadly speaking, in common parlance, fiscal stability is a situation in which the government is able to deploy its fiscal policy towards long-term economic objectives, which are high employment and growth rates.
2. That leads us to measures of fiscal stability. If you see the study of the State finances conducted by the Reserve Bank of India, you find that from 2005 onwards, in aggregate, States have adhered to the limit in terms of their gross fiscal deficit, which is the gap between the total revenue of the State and the total expenditure.
3. The mandate is under the ceiling of the fiscal responsibility legislation, which allows them to keep the gross fiscal deficit within an aggregate limit of 3% of GDP.
4. The only years — apart from the pandemic years — when these limits were breached were 2009-10, 2015-16 and 2016-17.
5. 2009-10 was a crisis year and 2015-16 and 2016-17 were years of power sector reforms in which power sector debt was taken over by the state governments.

 

What is the trajectory of the outstanding debt?

Outstanding debt reduction has actually progressed quite well in the case of the States.

From a high of 31% of GDP, it came down by almost 10 percentage points to about 22% of GDP by 2014-15. After that, it has inched up about five percentage points by FY 2020.

If we compare this with the Central government’s track record, the Central government has never been able to adhere to fiscal deficit limits.

Secondly, when it comes to debt reduction, the Central government’s debt-to-GDP limit is supposed to be 40%, but it has now crossed 90% of GDP.

So, the problem of fiscal stability is more pressing at the level of the Centre.

 

How much of this poverty reduction is due to growth versus the welfare measures taken by the Centre?

1. We don’t have official poverty estimates after 2011-12. The only estimates that we have are from a number of independent studies by private researchers.
2. There is at least one study that concludes that the rate of poverty reduction has slowed down under the Modi government.
3. There is also a consensus that the welfare measures such as the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) and the public distribution system, have contributed to poverty reduction.
4. The strengthening of these programmes has definitely contributed to poverty reduction. This does not mean that growth does not have a role to play in reducing poverty.
5. Remember, we are in a slowdown simply because demand in the economy overall has collapsed. And welfare spending has been able to at least prevent consumption demand from falling any further.

 

What proportion of spending by States is productive rather than aimed simply at gaining votes in elections?

1. In a democracy where political parties try and get votes from every section of the population, there is obviously a tendency for State governments to try and provide some kind of relief to voters.
2. For example, the MGNREGA type of spending and subsidy in the form of food ration schemes. These go a long way in increasing the productive capacity of the population. So, they’re not just doles.
3. They build a healthier and a stronger workforce, which is a necessary part of any growth strategy.
4. That is similar to a state spending on education or health. One can call these as an investment for the long-term, for improving the productive capacity of the population.
5. But yes, there are obviously cases where State governments have gone astray and have gone into providing all sorts of freebies or gifts.
6. But when it comes to simply giving away loan waivers, experts are not in favor of these because they have undesired consequences such as destroying the whole credit culture and it blurs the very basic question as to why is it that a large majority of the farming community is getting into a debt trap repeatedly.

 

Issue of unproductive and productive spending:

1. There are always ways to restructure bank loans to medium and small enterprises in the event of a downturn in the business cycle or any kind of extraordinary shock.
2. We can talk about loan waivers in the light of weather and other risks and also the fact that crop insurance has by and large always failed to offset shocks in agriculture.
3. Also, we are in a position where direct benefits transfer can be used to deliver loan waivers directly to distressed farmers and the cost of the waiver is immediately taken on the government’s budget and financial intermediaries are not involved.
4. The tendency towards unproductive spending is not more pronounced at the level of the States as compared to the Centre.
5. If we look at social sector expenditure, there is a rising trend at the level of the States, but then the rising trend at the level of the Centre is extraordinarily high.
6. And if you look at the core sector schemes, then the revenue spending component is as high as 65-68%. So almost two-third of the expenditure is revenue expenditure.
7. The issue of unproductive and productive spending should be looked at in this light and in the light of mounting interest payments.

 

Conclusion:

Fiscal stability is not just about expenditure but also about revenues. And mind you, the Centre also engages in giving out freebies not just to the poor people but also to a large number of corporations.

There is a need to understand the impacts of freebies from the economic sense and connect it with the taxpayers money.

It is also essential to distinguish between subsidy and freebies as subsidies are the justified and specifically targeted benefits that arise out of demands.