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P. V. Indiresan

Budget should address broad macroeconomic issues. But in all democracies, political pressures reduce it to mostly clerical microeconomic exercises targeting minute sections. The success of the coming Budget will depend on how well it shifts the emphasis from microeconomics to macroeconomics, says P. V. Indiresan.

BUDGET-making is like driving a cart with a bullock on one side and a buffalo on the other: the bullock pulls towards dry land, and the buffalo towards wet patches. Economists urge fiscal prudence; politicians demand more subsidies. Suppose the Finance Minister goes before the electorate boasting that he has brought the fiscal deficit under control. How many electors would understand what that means? Would that fetch him more votes?

Ideally, a Budget should address broad macroeconomic issues. However, in all democratic countries, political pressures reduce Budget-making to mostly clerical microeconomic exercises targeting minute sections of the economy. The success of the coming Budget will depend on how well it shifts emphasis from microeconomics to macroeconomics.

We needed a paradigm change to get out of the rut of the Hindu Rate of Growth. If the Finance Minister is serious of raising the growth rate to 8 per cent, he should initiate yet another paradigm change. He should stop propping up failures and start rewarding the competent.

Too many artificial impediments rather than too few resources are the cause of retarded progress. For example, we are sitting on a mountain of grain, and yet many villagers are going hungry only because they cannot find jobs. Similarly, at the not too extravagant standards of New York, we will need barely 0.2 per cent of the land area of the country. Yet, most of our urban dwellers are forced to live in appalling slums that are ten-twenty times more congested than New York even because they cannot find jobs in small towns, which alone offer affordable housing. Likewise, Our banks are flush with money — both rupees and foreign exchange — but they have no takers because entrepreneurs find it difficult to start new enterprises. Further, though we have an army of civil servants, the service the citizens get is poor.

These are all flaws in resource allocation. The existing paradigm not only retards economic progress, it angers the electorate too. The government should give up its dream of 8 per cent growth, and of winning elections unless it is willing to change the prevailing culture of finance and administration.

Prevailing flaws are the result of wrong policies dictated by political pressures. Current Rozgar Yojanas do not create jobs; they merely waste money. Subsidising slums does not create more housing; it ends up by making housing worse, and more expensive too. Rigid labour laws do not guarantee job security; they merely lead to less employment. Increasing the number of government employees does not help citizens; they only slow down growth. These are flaws within the provenance of the Finance Minister to correct, if not entirely, at least significantly.

For instance, we offer subsidies to job seekers. Instead, suppose we subsidise job creators. Consider a tax rebate to employers (who are the true job creators) equal to, say, 20 days' minimum wage for every full time employee. That will not cost the government much because large businesses, which contribute most to taxes, employ relatively few workers. This tax rebate will mean little to them. On the other hand, small businesses — the main job creators — will find this kind of subsidy a valuable incentive to expand.

This subsidy to employers has two advantages: One, unlike the various Rozgar Yojanas, which offer subsidies before a job is found, this subsidy comes into effect only after a job is created. Hence, it is less likely to be misused. Two, this subsidy will function better than the excise rebates that are currently provided as a sop to small industries. Excise rebate condemns small businesses to remain small. Tax subsidy based on employment encourages them to grow without limit so long as wages are not extravagant. Even if wages start to rise, the tax benefit diminishes slowly; it does not cut off abruptly the way excise rebate does.

Next, consider the problem of urban housing. It is now common knowledge that the acquisition of a house changes both economic habits and psychological behaviour for the better. In addition, housing industry has large employment potential even for unskilled workers. Hence, in a well-ordered polity, housing should be a thrust area. That is why, even in a developed country like the US, new housing starts are treated as significant indicators of the health of the economy.

We have choked the housing industry by virtually concentrating economic growth in extremely expensive cities. Once again, it is a case of microeconomics distorting macroeconomics. In this case, employers enjoy so many positive externalities in congested cities that they will not shift to socially superior locations.

Congestion tax is the answer. In developed countries, where housing is not the problem but cars are, congestion taxes have been used to reduce traffic density. Developing countries, which have fewer cars but suffer from exploding slums, the congestion tax should be designed to reduce housing density. For instance, a deterrent tax may be levied on buildings with high floor space ratios, and in locations where built-up space is in excess of open space. Such a tax will neutralise the positive externalities employers currently enjoy in congested cities. Once that externality is neutralised, employers will disperse to less crowded, less expensive towns. Labour will then find housing affordable. They will start buying many goods for which they have no space to keep at present. The economy will experience a healthy jump in demand. Politically, it is impossible to remove the near absolute security that our labour, enjoys. Unwanted labour is so large in numbers that we cannot afford unemployment insurance. As the economy is growing quite fast, the problem is not absence of new employment but the unemployability of redundant labour in new areas of growth. The correct solution is for the government to make it attractive for labour to keep abreast of new skills and to opt for jobs on contract. For instance, entire savings may be made tax deductible only for those who are on temporary jobs but not for those who are in permanent ones. The government may also offer unemployment insurance for those that acquire new skills. With such workers, even if their current job becomes obsolete, their skills will not. They will remain employable. Unemployment insurance for such people alone will be affordable.

The present system treats both the timorous and the adventurous alike; this scheme will help both, but in different ways. The former can opt for permanent employment, and get security — but at a smaller take-home pay (or less savings), static skills, and static opportunities. The latter opt for risky contract appointments but will always have valuable dynamic skills, which offer opportunities to progress rapidly. They will also have the benefit of subsidised unemployment insurance.

Of all anomalies that are afflicting our economy, the strange situation of unwanted credit is the saddest one. That is due to the reluctance of entrepreneurs to start new ventures. Here, poor governance is the real impediment.

Currently, all government establishments operate on the principle of deficit financing by which the government underwrites to meet, in full, all expenses in excess of income. Because it guarantees to meet all expenses, anticipated and unanticipated, the Finance Ministry appropriates to itself whatever income is earned. Deficit financing is spoon-feeding. It discourages government establishments from generating new revenue because the whole all that will be taken away. It does not encourage economy either because, after all, all expenditure, both good and bad, is underwritten.

There is a better alternative known as block grants. In this case, the government provides a fixed grant irrespective of expenditure. That imposes an onus on government establishments to earn enough to meet the difference between the actual expenditure and the block grant. With block grants, establishments are free to retain their earnings, and to spend that income as they think best. That freedom inculcates an enthusiasm to earn more. Earning more becomes so rewarding that establishments on block grants will have no option but encourage entrepreneurs, and to promote rapid growth. We need a paradigm change to get at 8 per cent growth — particularly, a change in the way we budget subsidies and taxes. By themselves, subsidies are not a problem. Ill designed, wrongly targeted, dishonestly implemented subsidies are the problem. For instance, rural employment subsidies target those that have failed. Excise rebates for small business reward merely being small. Instead, subsidies to employers based on numbers employed reward thrift and the ability to create jobs. Unemployment insurance rewards failure to retain jobs. Training subsides and insurance for those who accept jobs on contract reward conscientiousness and risk taking. Likewise, corporate tax penalises success but congestion tax penalises social irresponsibility.

The coming Budget will succeed or fail depending on how well it changes the operating paradigm.

(The author is former Director, IIT Madras. Response may be sent to: indiresan@bol.net.in)

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