India is a populous country that has unfortunately long neglected investing in its people by giving them uniform access to good education, relevant skills, clean air, water, smooth connectivity and other facilities.
Many of these are prerequisites for participating in, gaining from and sustaining growth. That is why spending more on and improving governance in local institutions responsible for delivery of human and physical capital is essential.
Our early choice to subsidise production as well as consumption of food pre-empted funds and led to bouts of inflation that derailed growth. East Asia that chose instead to invest in agricultural productivity did much better.
Fortunately, the Centre has improved the quality of its spending. But in States, parties are competing to offer transfers that entail a heavy fiscal cost given the size of our population. Palliatives that do not build capacity have to continue indefinitely.
Competitive populism
For example, in the run-up to the Maharashtra elections one party started with ₹1,500 per month to 2.5 crore low-income women at a cost of ₹45,000 crore; post-election it promised ₹2,100; the opposition promptly announced ₹3,000.
In Jharkhand also competitive bidding has raised the amount from ₹1,000 to ₹2,500. Fourteen States have jumped on the bandwagon, covering 20 per cent of India’s women. The cost of these schemes is likely to be poor delivery of facilities that would enable women to earn more themselves.
Constitutional caps on State deficits are necessary to preserve macroeconomic stability, but States then have to reduce other types of spending to finance the schemes. Many will cut capex. So while the quantity of expenditure may not rise, its composition will change. The dominant share of the money that goes to low income women will be spent on a diversified food basket.
Policy mismatches
But our food policy supports foodgrains at considerable direct and indirect cost, although consumer demand is shifting to other foods. Supply chains for items such as vegetables suffer from poor infrastructure and restrictions on private procurement, although improved rural roads are helping.
Even in States such as MP, where the grip of mandis and middlemen was relaxed, the absence of cold storages prevented private players coming in. Private investment in infrastructure is inadequate since they don’t capture externalities. So States have to step in. But they are giving subsidies that will increase the demand for vegetables without relaxing constraints on the expansion of supply.
As a result of this policy mismatch prices will rise for consumers, but most of the increase will continue to go to middlemen, so production will not rise as required. The tragedy of the 2010s can play out again, where high food inflation forced a squeeze of industrial demand reducing investment and growth. Then also transfers to agriculture peaked without relaxing supply constraints.
Already spikes in vegetable prices are delaying rate cuts despite slowing growth. Current attempts to remove food from the inflation target won’t work as inflation expectations and wages rise, generalizing inflation as in the 2010s.
Escape routes
The way out is if parties recognize this doom loop and agree to a common set of minimal well-targeted welfare measures and then compete on improving governance and delivery of public services. There is a rationale for some transfer to a shrinking set of poor women, since it empowers them and they use the money to benefit their families.
But States are finding it difficult to fulfil broad election promises. There are many analysts now to point out failures, costs and trade-offs between different types of spending. Rising voter awareness can enforce better polices, which require optimal use of funds. Women are also asking for jobs that can give them more than the state doles. They are averse to food inflation that eats into the little they get.
The initiative announced in the Budget to improve policy coordination with the States and efficiency of public resource use is an opportunity for inter-party dialogue that can help create commitment mechanisms to stop the ongoing race to the bottom.
Since offers are matched by others political advantage from freebies is quickly lost, while the space for pro-development expenditure shrinks. We are still suffering from the ill effects of the last wave of competitive populism in the seventies, when free electricity for farmers became the norm.
It is better to begin with low hanging fruits and win-win policies that generate the least political resistance, rather than getting bogged down in factor market reforms that foreign investors want. The set of feasible policies often work with new technologies. Today second generation reforms should be about building digital platforms to harmonize standards and match funds to projects.
But difficult reforms can also start as small decentralized pilots that can be scaled up if they work well. States where ground conditions are better can move forward on controversial reforms. Successful pilots would improve political acceptability in other States. They would not like to be left behind.
For example, Haryana is a more prosperous State with a lower share of population dependent on agriculture and a better infrastructure of warehouses and cold storages. It could improve these further (announce a state cold storage corporation) and offer other incentives for farmers to diversify cropping patterns. This could have a valuable demonstration effect on farmers in Punjab.
Power distribution is another area with the worst fallout from freebies. Due to uncompensated free power cumulative losses in this sector are above ₹6 trillion. Distorted prices create misallocation of resources. Investment is inhibited. States that simplify regulations, improve governance and transparency will be able to get more of the green finance becoming available. Restrictions to protect cross-subsidization are obstacles to such essential greening.
The policy framework should encourage convergence across States by communication of success stories/schemes in individual States. For example, Odisha is at the top of all State rankings today — least debt, lowest share of interest payments releasing funds for productive investment. This started with a simple decision in the early 2000s, backed by better accounting systems, never to borrow for revenue expenditure.
Active listening is also required to adapt schemes to and re-design them for local conditions, combined with continuous attempts to point towards improving efficiency and capability in different tiers of government as the only long-term sustainable solution. Dialogue is necessary for working together well.
Governance and policy implementation in States and lower tiers is often plagued by multiple institutions with overlapping responsibilities leading to infamous court delays and pile-ups. Working towards clear hierarchy/devolution/merging or coordination mechanisms is important.
Conditionalities must also continue to be used. Discipline and incentives imposed by independent central/constitutional institutions has worked in the past. Examples are State debt reduction incentives to adopt fiscal responsibility. Conditional grants have improved the capacity of and devolution to the third tier. Almost 90 per cent of 2.55 lakh panchayats had online accounts by 2023.
Interest free central long-term loans conditional on capex induced a double digit rise in States’ capital spending over 2022-24, protecting investment from cuts despite substitution away from States own investment funding due to populist spending.
The writer is Emeritus Professor, IGIDR