In order to overcome the problem of inefficiencies in the subsidy system, the Finance Ministry has endorsed two ideas that have been floating around for a long time: give the poor coupons or give them cash.

When the Finance Minister said this during his Budget speech, Sonia Gandhi was seen thumping the desk in approval — which means the NAC has lost the battle.

Both ideas — cash and coupons — are based on a bit of off-hand classroom research done by an American economist at Yale, Joel Waldfogel, more than 20 years ago.

He found that gifts in kind — which, when you come to think of it, is what subsidised goods are — lead to a lot of waste. It is better, therefore, to give cash or vouchers/coupons.

This would prevent what in economics is called ‘deadweight losses' which arise because it is impossible to accurately rank someone else's preferences. (Just think of all the gifts you have received in the last 10 years).

 

Not that simple

The Government, however, needs to beware of two difficulties that will arise. One is that what works in small lots need not work in very large populations. And, two, coupons could become a substitute for cash with a very important difference — they could acquire a premium value just as World Cup tickets given to clubs have done.

This will hit the poorest hardest because they will have to buy things at a premium from persons who may have higher preference for cash to buy something other than what the coupon entitles them to.

Indeed, these coupons in Indian conditions could become a substitute for cash — which is outside the control of the RBI. Also, there will be a slight rise in the money multiplier which is almost 4.9 now.

Problem with cash

Logically, therefore, only cash should be given to the poor as Bihar has been doing under Nitish Kumar. This is what the unemployment doles in the West do

But there are two problems with doling out cash: one, the payments will have to be indexed to inflation; but, two, if they are, why would anyone look for a job? This is the old moral hazard problem in economics.

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