Growing election freebies are a threat to the Indian economy: Lessons from Maharashtra

The political economy of freebies can derail the economy

The political economy of freebies can derail the economy

The principal development this week has been the consolidation of the BJP-led National Democratic Alliance’s political authority, as manifested by its resounding victory in the Maharashtra assembly elections. The BJP won about four fifths of the seats it contested, and is 20 short of an absolute majority on its own. This renders it immune to defection of alliance partners to the Opposition camp, as had happened in 2019. The markets cheered the outcome briefly, and then went back to worrying about India’s economic prospects in a Trumpian world.

Perhaps, the markets should worry more about the new political economy of fiscal handouts that is getting established with the Maharashtra election result.

In the Parliament elections that concluded in May this year, the Opposition India bloc had won 30 of Maharashtra’s 48 seats. One seat had gone to an independent, leaving the NDA with 17 seats, and, within that, the BJP with 9 seats. The remarkable turnaround in the BJP’s fortunes just in six months’ time is broadly attributed to two factors.

One, the BJP brass having made peace with the Rashtriya Swayamsevak Sangh, the Sangh’s cadre went to work mobilizing votes during the assembly elections, after having stayed away miffed during Parliament elections. Two, in July, after the Parliament election results had exposed its vulnerability, the BJP-led ruling alliance of Maharashtra, called the Mahayuti, introduced a cash transfer scheme for women in the age group 18-65 and with incomes below Rs 250,000 a year. The scheme, called Ladki Bahin Yojana, transferred Rs 1,500 every month to all eligible women who registered for the benefit. In every family, up to two women could claim the benefit.

During the assembly elections, the Mahayuti promised to increase the benefit to Rs 2,100 a month. The Opposition alliance, too, promised similar handouts.

This is not the first cash dole in India’s political history. The Mahatma Gandhi National Rural Employment Guarantee Act promises all rural folk who turn up for manual labour up to 100 days of employment at the minimum wage. The PM Kisan scheme gives farmers Rs 6,000 per year each. Very many state governments have their own benefit schemes, apart from subsidies. Subsidies can be explicit or implicit. Unbilled power to farmers and free irrigation water are implicit subsidies, whose precise extent is not measured and budgeted.

Subsidies on railway passenger fares, on urban transport, on higher and school education, on forgone tax on housing loans and statutory savings such as provident fund and pension fund contributions, on school education, on healthcare, and so on are a jumble of merit subsidies and de-merit subsidies.

How do we distinguish a merit subsidy from wasteful subsidies? Take something like school education or primary healthcare. The direct beneficiary of either service would be willing to pay, if she can afford it, as much as it is worth to receive that service. However, the individual consumer of the service does not take into account the benefit that accrues to society and the economy at large from having an educated, healthy workforce. In order to elicit a supply that fully takes into account the greater social benefit, the state would spend, over and above what individuals are ready to spend on these services. A merit subsidy, thus, is the additional payment the government makes to increase the supply of something whose social value is greater than the aggregate of individual gain to direct beneficiaries. Food subsidy is also a merit subsidy, spent to avoid having a society in which people die of hunger when enough food has been produced and is available. Merit subsidies are not just legitimate but required, to optimize collective welfare.

But non-merit subsidies are meant to curry favour with the voters. In the case of the Ladki Bahin scheme, the fiscal burden, as a proportion of Maharashtra’s state domestic product, would probably be less than 2%. Why worry about such schemes then?

The trouble is that Ladki Bahin, having established itself as a vote winner in Maharashtra, is poised to spread to other states. Prime Minister Modi condemned such transfer schemes ‘revdi’, a sugar sweet containing sesame seeds, as a metaphor for unhealthy inducement. Now, India’s political economy is poised to collectively take the flavour of revdi.

This would not matter, if India had sufficient fiscal room to splurge on such goodies. India does not. Total tax collections by the Centre and the states together add up to some 17% of GDP. The average for rich countries, defined as members of the Organisation for Economic Cooperation and Development (OECD) is double that much. Non-tax receipts (the likes of telecom licence fees, spectrum auction receipts, dividends of public enterprises and the RBI, interest received on loans made by the government, recovery of loans, disinvestment proceeds) come in well under 3% of GDP. So, without borrowing, the government can spend 20% of GDP.

Faced as India is with a powerful, hostile neighbour to the north, India has to spend liberally on defence. Excluding capital expenditure on defence procurement, and including salary and pension payments, the government consumption expenditure is about 10.5% of GDP (https://data.worldbank.org/indicator/NE.CON.GOVT.ZS). The Centre and the states together have an accumulated debt equal to some 80% of GDP. Assuming an average interest rate of 8%, the interest outgo would be 6.4% of GDP. The scope for public investment and discretionary expenditure is limited to 3% of GDP without borrowing.

Significant amounts of revdi would simply result in additional borrowing, and further hikes in the share of interest payment as a share of the Budget and the GDP, leaving the government powerless to spend on the things that would make the economy stronger and more competitive.

The political economy inaugurated by the ruling alliance’s victory in Maharashtra is, in other words, injurious to national prosperity.