Opportunity costs of election-time freebies
The Centre must lead on the freebie issue, and start a conversation on its fiscal implications
Freebies are in full flow this election season. Arguably, Prime Minister (PM) Narendra Modi’s enormous popularity owes to the significant expansion of welfare schemes on his watch rather than any big initiatives to help the poor improve their livelihoods on a sustainable basis. The Congress, on its part, is hoping to script its comeback at the national level by upscaling the “guarantees” that fetched its electoral success in Karnataka and Telangana. Regional parties which have historically been at the forefront of handouts are vying with each other to woo voters with freebies. And no one is asking any questions about where the money for all this will come from. There is a strong case for restraint.
For sure, in a poor society where millions struggle for daily livelihood, the government needs to provide some safety nets to the most vulnerable. But this spending has to be within limits, especially as these transfer payments are financed by borrowing. Whether it is a household, a corporation or the government, ideally a loan should repay itself by generating a future income stream. On the other hand, borrowing money just to redistribute it as handouts can be fiscally perilous.
Freebies have an opportunity cost. The money spent on them could be spent on roads, education and health which would aid growth and welfare on a more sustainable basis than would mere handouts. As Mao Zedong said, “Give a man a fish, and you feed him for a day. Teach him to fish, and you feed him for a lifetime.”
The question then is why are people voting for freebies. Because it is in the very nature of poverty that the poor tend to prioritise the short term over the long, especially when confidence that politicians will deliver better services is low.
Even as the Centre and states have gone overboard on freebies, the fiscal constraint is arguably much greater for states. The Centre has enjoyed larger budgetary resources consequent on economic growth which has made it possible for it to expand welfare schemes without seeming profligate. States have not had similar buoyancy and cannot, therefore, afford to spend on handouts without seriously jeopardising their debt sustainability. It’s at the state level, therefore, that restraints are more urgent.
There is an argument that this concern is being exaggerated. After all, if you look at the analysis of state budgets by the Reserve Bank of India (RBI) or any think-tank, the inference you will draw is that state public finances are in good health and that they are, in fact, conforming to the Fiscal Responsibility and Budget Management (FRBM) targets.
This is misleading. State governments are able to hide their borrowing from FRBM tracking by borrowing on the books of their public enterprises, in some cases offering future revenue as collateral.
But what of the checks and balances that are supposed to govern democracy? Regrettably, they have eroded in the case of freebies.
The first line of defence has to be the legislature, in particular the Opposition. But no Opposition party dare oppose any freebie for fear of losing the vote bank at the receiving end of the freebie. If anything, the Opposition will taunt the government into giving away even more so as to get credit for the enhancement.
In theory, the Comptroller and Auditor General audit, which can legitimately comment on the debt sustainability of a state, can be a check. However, in practice, audits have failed to bite because they come with a lag when political interest has moved on to other issues. Moreover, our bureaucrats have mastered the art of turning audit paras into “files”, which run their course and die a quiet death.
As states pile on debt year after year, interest payments are guzzling up an increasing share of their revenues leaving that much less for other discretionary expenditures. In theory, the market can check profligacy by pricing the loans of states based on their debt sustainability. Thus states like Karnataka and Maharashtra with stronger fiscal positions will command a lower interest rate than more indebted states. This signalling mechanism is lost, however, in our system because the market assumes that all state loans are guaranteed by the Centre, never mind that there is, in fact, no such guarantee.
There has been a suggestion that the Election Commission (EC) should step in to rein in freebies. The nature and extent of the EC’s authority in this regard is not clear. One view is it can mandate political parties to necessarily indicate the fiscal implications of the freebies they are offering. No matter the powers of the EC, it’s not advisable for it to get into this business. It should not be distracted from its core business of conducting free and fair elections. In any case, it should not get into what is quintessentially a political issue at a time when its political neutrality is being questioned.
There was a time not long ago when the Centre dominated the fiscal space and state-level public finances didn’t matter much. That is no longer the case.
Today, states collectively borrow as much as the Centre, and put together they spend more than the Centre. Our debt sustainability and macroeconomic stability are, therefore, as much a function of the Centre’s fiscal position as that of the states collectively. It’s not enough that the Centre becomes fiscally responsible; it has to carry the states along too.
One of the first tasks for the Centre in that leadership role is to evolve a political consensus on capping the spending on freebies. There are reports that the PM has tasked the bureaucracy to come up with a hundred-day plan of action for the new government. Let’s hope a “discussion paper” on freebies will figure in that action plan and will be taken up on priority no matter which party comes into office post-election.
Duvvuri Subbarao is a former governor of the Reserve Bank of India. The views expressed are personal
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