Handling Fiscal Deficit in India

On Oct 29 the Indian government Monday outlined a five-year fiscal consolidation plan that aims to nearly halve the deficit by 2017 and cut it to 5.3 percent (slipping from the targeted 5.1%) of the gross domestic product in the current financial year. The fiscal deficit had risen to 5.8 percent of GDP at the end of the financial year 2011-12. Higher spending on fuel, food and fertilizer subsidies along with sluggish tax revenues has led many economists to forecast a fiscal deficit this current fiscal year of about 6 percent of GDP. As per the plan outlined by the finance minister, the government's fiscal deficit would come down to 4.8 percent in 2013-14, 4.2 percent in 2014-15, 3.6 percent in 2015-16 and three percent in 2016-17. However, the government did not specify the measures that would help reduce fiscal deficit consistently. 

The International Monetary Fund this month slashed its economic growth forecast for India for 2012 to 4.9 percent from 6.1 percent previously. Rating agency Standard & Poor's said the country faces a one-in-three chance of a credit rating downgrade to junk over the next two years.

The government assigns several reasons for the fiscal stress including the slowdown in the world economy, lower growth in India, higher inflation, lower tax receipts and increased expenditure, including subsidies. The government feels that if it does not rein in expenditure at this point the economy may go into a cycle of low growth, high inflation and high deficit. The government feels that as fiscal consolidation takes place and investors' confidence increases, it is expected that the economy will return to the path of high investment, higher growth, lower inflation and long-term sustainability. The Kelkar committee has recommended rationalization of schemes and strict control and monitoring of expenditure. The process to contain the deficit will include the usage of unique identity number - Aadhaar - to distribute subsidies to the below poverty line population, thereby plugging leakages.

At this point I only fear that the government might go into an overdrive of reforms. It is attempting to manage the subsidy burden better by using an Aadhaar based system. The Public Distribution System (PDS) and fertilizer subsidies seem to be prime candidates for the effort. I feel that these are steps in the right direction and leakages of subsidies should be curbed. These are in any case low hanging fruits. Greater effort would be needed in better directing subsidies, a task at which most government s have balked. The capture of subsidies directed at the poorest of the poor by the well-off sections is omnipresent and all-pervading in most subsidies. 

I would like to illustrate my point with the example of the Aadhaar based delivery of essential food commodities. The Aadhaar ensures that ghost cardholders do not draw their rations and this is in itself no mean achievement. The District officials of the East Godavari district have stated that in their district wide pilot implementation they have realized savings of more than 30% in the commodities being distributed. The government has the difficult task of repeating this in all the districts of the country. This is a tall order in view of the differing levels of education and development across districts and ability to absorb the technology.

The government hasn’t still sunk its teeth into the more difficult task of better directing its subsidies and ensuring that they reach the poorest of the poor. In the state of Andhra Pradesh there has been a proliferation of ‘white ration cards’ with an intention to corner several subsidies which are directed at the poorest of the poor. Governments have political sensitivities which make this task all the more difficult. In fact, such tasks have proved to be very difficult all over the world. However, without addressing these basic issues, the structure on which our growth is built would be weak. I feel that we need to be the master of where we decide to spend our money and we should not look the other way when resources are drawn away against our collective will.

I would only like to point out that that the social services net in India is still very weak and has large holes to be filled up. Under the circumstances across the board cuts might hurt our society more than any benefit that would accrue. I only hope that the manager involved in the task would ensure that we don’t weaken our social services net any more than it already is.

Rent seeking and Inequality - I

“ A simple definition of rent seeking[1] is spending resources in order to gain by increasing one's share of existing wealth, instead of trying to create wealth. The net effect of rent-seeking is to reduce total social wealth, because resources are spent and no new wealth is created.”  Rent seeking is not profit sharing as profit sharing attempts to create wealth whereas rent seeking does not do so. In economics, rent-seeking is an attempt to obtain economic rent by manipulating the social or political environment in which economic activities occur, rather than by creating new wealth.”

 The origin of the term is from extracting rents due to ownership of land rather than profit from actual cultivation. The mere possession of the given land resource entitled the holder to rent and the holder was not obligated to work the land and create wealth. In most cases the land was inherited wealth implying that the holder had no need to work to be in possession of the same. Hence the land holder was able to appropriate wealth on account of his position and not due to dint of hard work.

Rent seeking is seen in many areas of the economic sphere and is in its most vicious form when stemming from government regulation of free competition and thereby increasing inequality in society. An example of rent-seeking in a modern economy is effort made by firms and individuals to obtain control of various natural resources like mines, urban& rural land through lobbying and leveraging political strength and thereby corner profits from them.

Historically people and groups in power have always tried to increase their power and wealth and in the very least at least maintain them. They have a variety of instrumentalities to maintain the same. In the medieval ages, the king and the nobility ensured that they cornered a large part of the wealth of society. The religious classes also took shelter behind holy duties to maintain wealth and power. The spread of democracy and breakdown of medieval structures has made it difficult for these classes to corner wealth and power with the same reasoning and hence they had to search out justifications in tune with prevalent thought.

Post Industrial revolution the theory of marginal productivity primarily determined individuals who would get paid more for the work they put in. Demand and supply of labour determined the occupations which were better paid. The list of better paid occupations was never constant and varied with technologies of the time. Over a period of time the better paid occupations came to depend less on physical labour and more on brain power.

We can safely say that inequality in society would not increase if wages were paid based on marginal productivity. This however has not been the case and in present times the rules of the game have been skewed greatly to favor the wealthy. These rules, which are set by the governments and groups of individuals, affect the state of inequality in a society greatly. A famous example in regard to unfair rule setting is the limiting of access to lucrative occupations, as by medieval guilds or modern state certifications and licensures (Doctors, Lawyers etc.). Restricting entry to such professions help those that have already reached there to maintain their incomes and avoid sharing with newcomers. In economic parlance there are milking the rents of having already reached a given position by obstructing the cycle of demand and supply to the profession. People accused of rent seeking typically argue that they are indeed creating new wealth (or preventing the reduction of old wealth) by improving quality controls, guaranteeing that charlatans do not prey on a gullible public, and preventing bubbles.

As a country becomes increasingly dominated by organized interest groups, it loses economic vitality and falls into decline. [2] Olson argued that countries that have a collapse of the political regime and the interest groups that have coalesced around it can radically improve productivity and increase national income because they start with a clean slate in the aftermath of the collapse. An example of this is Japan after World War Two. But new coalitions form over time, once again shackling society in order to redistribute wealth and income to themselves. It looks as if a society needs to reinvent itself at regular intervals if it wants to avoid falling into the rut.

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[1] http://en.wikipedia.org/wiki/Rent-seeking

[2] Mancur Olson: The Rise and Decline of Nations

Income inequality in India

Inequality in income is at a very high level in India and has further increased over the past two decades. The increasing per capita income of the country should not lull us into complacency as we see that the lowest strata of society has got only a small portion of the development pie. We should also recognize that a good growth in the GDP does not mean good for the population at large and unless direct measures are taken by the government, this inequality would only increase.

The Gini index measures[1] the extent to which the distribution of income or consumption expenditure among individuals or households within an economy deviates from a perfectly equal distribution. A Lorenz curve plots the cumulative percentages of total income received against the cumulative number of recipients, starting with the poorest individual or household. The Gini index measures the area between the Lorenz curve and a hypothetical line of absolute equality, expressed as a percentage of the maximum area under the line. Thus a Gini index of 0 represents perfect equality, while an index of 100 implies perfect inequality.

The World Bank has computed India’s GINI (%) at 37 in 2005. The progressive increase in the Gini index [2]over the past few years shows that income inequality in India is only increasing.

Gini Levels	Early 1990s	Late 2000s (↘)			Years
OECD	0.30	0.31		6.3	2008
Indonesia	0.39	0.37		-6.7	2005-2009
India	0.32	0.38		16.0	1993-2008
China	0.33	0.41		24.2	1993-2008
Russian Federation	0.40	0.42		6.0	1993-2009
Argentina	0.45	0.46		0.9	1992-2009
Brazil	0.61	0.55		-9.4	1993-2008
South Africa	0.67	0.70		3.1	1993-2008

Another way to describe inequality is by looking at changes in household income for different groups [3], notably those at the bottom, the middle and the top of the distribution. Larger rises in income for those at the bottom and middle of the income distribution may, in particular, signal that opportunities and equalization are both growing. The truth in the case of India is that incomes of the rich are increasing at a greater rate than those of the poor, thereby exacerbating the income differential further.

There are several reasons for this persisting inequality. Some of the key sources include a large and persistent informal sector, widespread regional divides (e.g. urban-rural), gaps in access to education, healthcare and nutrition, and barriers to employment and career progression for women and weaker sections of society.

It is incumbent on the government of the day to take measures to address the issues causing inequality. It is however seen that the benefit and tax systems in India are far from effective in easing market driven inequality. The coverage and generosity of social protection systems is very poor as is evident from the low allotments for health and education in the budgetary spending.

At the same time, the tax system delivers only modest redistribution, reflecting such problems as tax evasion and administrative bottlenecks to collect taxes on personal income.

Reducing inequality while working towards higher growth in the country requires a multipronged approach. The approach should include: 1) provisions of social assistance that target those most in need; 2) spreading the rewards from education; and 3) preparing to finance higher social spending in the future.

It is important to underline that tackling inequality goes beyond the remit of labour, social welfare and tax policies. Other policies, such as those aimed at improving the business environment, product market regulation, infrastructure development, health care and public administration reforms also have a role to play in reducing inequality.

Conditional cash transfers may be particularly well suited to reducing inequality and promoting social mobility in the country. The fact that they could combine income support with the requirement to maintain investment in human capital and child health means that they can be useful tools not only for tackling household poverty, but also for promoting school enrolment and improving healthcare for children.

Addressing inequalities in both access to, and quality of, education can also make an important contribution to lowering inequality in labour income.

Enhancing the distributive capacity of the tax system would require an emphasis on improving revenue collection procedures and strengthening the extent to which taxpayers comply voluntarily with their obligations. A focus on the fight against corruption would also help improve tax collection.

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[1] http://en.wikipedia.org/wiki/Gini_coefficient

[2] http://dx.doi.org/10.1787/888932535432

[3] http://dx.doi.org/10.1787/888932535451