Terms of Trade: Are freebies also serving a macroeconomic cause?

Instead of being a drain on growth-enhancing resources, freebies might be serving a useful macroeconomic purpose in the short-term

The political class seems to have arrived at a consensus on so-called freebies. The Bharatiya Janata Party (BJP) was critical of their proliferation until recently. Prime Minister Narendra Modi used to refer to them pejoratively as the “rewdi” culture. Not anymore. Beginning from the 2023 Madhya Pradesh elections, the BJP has realised that freebies generate traction in elections and might have become the necessary if not sufficient ingredient of a successful election campaign strategy.

Women express happiness over the deposit of ₹3,000 in their accounts under the Maharashtra Government's Ladki Bahin Yojana on August 16, 2024. (Hindustan Times)

The political consensus notwithstanding, do freebies serve a useful economic purpose? Many commentators, including this columnist, have argued that freebies are essentially a drain on other essential and long-term growth/welfare enhancing spending resources and therefore anything but a prudent strategy in the long-term.

But is this all? Here is a slightly provocative line of reasoning that suggests that they might be serving a useful macroeconomic purpose in the short-term. Let us begin with a brief snapshot of India’s macroeconomic story in the past two decades.

In 2006, the first United Progressive Alliance (UPA) government implemented the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS). It was a game changer as far as India’s unskilled labour market was concerned. Workers were assured 100 days of guaranteed (low-paid) employment in villages across the country for the first time. This is bound to have given a boost to the bargaining power of the unskilled worker in the Indian economy.

A spike in real rural wages – they are the bellwether of unskilled wages throughout the economy – a couple of years after MGNREGS’s roll out provides empirical support to this claim. Given the fact that both rural and urban inflation measures (back then we did not have a common CPI series) started rising a couple of years after MGNREGS’s roll-out as well, the argument that MGNREGS’s boost to labour’s bargaining power might have set-off a wage-price spiral in the economy is not entirely implausible.

Of course, this is not to say that it was the only factor. The economy was booming, there was a global commodity price super cycle and the government went into a fiscal expansion mode to cushion the impact of the 2008 Global Financial Crisis on the Indian economy. But as the boost to real rural wages shows, the labour market factor was not insignificant.

Inflation would eventually come down with an easing of commodity, especially crude oil prices, a lowering of the fiscal deficit and, fast forward to the post-2016 period, a slowdown in growth itself. But what is likely to have helped the process is the massive expansion in the food security programme via the 2013 National Food Security Act which brought almost 800 million people into the food safety net. The NFSA cushioned this population from inflationary impact for staple cereals.

This was followed by another spurt in various kinds of income support programmes, both from the Centre and the states, from the 2019 Lok Sabha election cycle onwards. According to various estimates going around, the fiscal quantum of such income support programmes is likely to be more than the entire amount of food subsidy in the country which already exceeds ₹2 lakh crore.

A number of important people, the list includes Supreme Court judges and the chairman of Larsen and Toubro, think that these benefits have made the blue-collar workforce less inclined to work because the opportunity cost of not doing work is not as high as it used to be (read: starve) in the pre-freebie world. Logically, there is nothing wrong with the argument. It a worker has access to a welfare cushion, even if bare minimum, it is to be expected that he would have a slightly high reservation wage.

However, this need not be the only way to look at this problem. What if these benefits did not exist at all? It is interesting to think of two kinds of possibilities.

Given the fact that the Indian economy has lost momentum compared to the first decade of the 2000s and the informal sector has come under a particular squeeze after the policy-induced shocks of demonetisation and Goods and Services Tax (GST), one would have expected real wages for unskilled workers to fall during this period. While real wages have indeed been flat, they have not fallen discernibly.

On the other hand, there is evidence to suggest that formal sector wages at the entry level have fallen significantly in real terms. Entry level salaries for IT companies, for example, have been flat for almost a decade now. Is it the case that this welfare cushion has also provided a floor to minimum wages for the unskilled workforce in the country? If yes, then they have provided a critical buffer to consumption levels of the poorest in this country. This is likely to have prevented political anger and also prevented a worsening in nutritional indicators, which have actually improved.

To be sure, some of this consumption buffer could have been inflation-generating. For example, a December 2024 research note by Axis Bank chief economist Neelkanth Mishra says that “a meaningful part of it (cash transfer programmes) is likely to be (spent) on food” which might have created “nearly half a year worth of additional demand” which “could take a few quarters for supply to respond adequately”.

While this might have had an effect of stoking food inflation despite core-inflation being much lower, there is a question to be asked here. Because this extra money is coming from the government’s rather than the capitalist’s coffers, can one argue that it is unlikely to be passed on in the form of higher prices of non-food items in the economy at large, which is what would have happened had firms been paid to bear the cost of this additional income to the unskilled workforce.

Does this mean that cash transfers can at worst lead to food inflation without triggering a wage-price spiral of the kind of which was kickstarted by the MGNREGS in the period when NFSA and other cash transfer programmes did not exist? If this is indeed true – it would take a much more rigorous analysis than a newspaper column to prove or disprove this analysis conclusively – then it is indeed an interesting macroeconomic implication of freebies. While it is a bit rich to expect judges and CEOs to appreciate this, economists, especially those who track inflation, might find it interesting.

Roshan Kishore, HT’s Data and Political Economy Editor, writes a weekly column on the state of the country’s economy and its political fallout, and vice-versa.