Chidambaram vs Ahluwalia

Financial Express, 29 August 2006

In his letter to Planning Commission deputy chairman Montek Singh Ahluwalia, Finance Minister P.Chidambaram has raised a number of questions about the Eleventh Plan Approach Paper. The most important objection, and perhaps one that is binding, given that Chidambaram holds the purse-strings, is his objection to the Planning Commission's proposal to shift FRBM targets.

Before deciding whose side are we on, we need to answer two questions. First, what will be the cost to the economy of shifting FRBM targets, and second, do the benefits from higher spending justify these costs.

Higher GDP growth in the last three years has come from higher investment. In the period from 2001-02, there was an increase in the investment rate by 7 percent of GDP. The investment rate rose from 23 percent in 2001-02 to 30.1 percent in 2004-05. This investment was financed by a rise in both the gross savings rate and net capital flows from abroad. The domestic savings rate rose from 23.6 percent in 2001-02 to 29.1 percent in 2004-05. Household sector saving remained between 22 and 23 percent of GDP. Corporate savings rose marginally from 3.6 percent of GDP in 2001-02 to 4.8 percent of GDP in 2004-05. The net capital inflow improved from a net outflow of capital from India of 0.7 percent of GDP in 2001-02, when India witnessed a current account surplus, to 0.9 percent of net inflow of capital into India in 2004-05.

The component of saving that showed the most remarkable swing was public savings. In 2001-02, the public sector as a whole was making losses of Rs 46,377 crore. In 2004-05 the government and public sector enterprises together saved Rs 69,390 crore. This was a shift from -2.0 percent to a postitive of 2.2 percent of GDP.

One important part of the increase in the public saving rate was achieved by fiscal consolidation at both the state and central levels. The combined revenue deficit of the central and state governments is estimated to fall from 7.0 percent of GDP to 3.4 percent in 2005-06 (Budget Estimate). The combined fiscal deficit of the centre and states has fallen from 9.9 percent of GDP to 7.7 percent over this period.

Shifting FRBM targets, as proposed by the approach paper, would mean decreasing public savings by upto 2.5 percent. If the current account deficit rises by 1 to 1.5 percent from the present 1.3 percent, it can finance an additional 1 to 1.5 percent of investment. A CAD of more than 3 percent may not be sustainable. So shifting FRBM targets would mean lower investment and lower growth.

But, before we conclude that higher deficits are a bad idea, we need to look at the benefits of the spending proposed by the Planning Commission. The Approach Paper says that an additional 1 to 2.5 percent of GDP would be required to be spent on the NREGA, health, education and irrigation.

Do the benefits of the additional spending justify endangering growth?

The answers are found in the approach paper itself. The evidence on the effectiveness of centralised schemes for primary education such as the Sarva Shiksha Abiyan is very poor. The paper cites a Pratham study which finds that 38 percent of children who have completed four years of schooling cannot read even short sentences. 55 percent of such children cannot divide a three digit number by a one digit number. It admits that these are indicators of how bad things might be in the learning of other subjects.

Similarly, the Eleventh Plan Approach Paper notes that rural health care in most states in India is marked by absenteeism of health providers, low levels of skills, shortage of medicines, inadequate monitoring and callous attitudes. It says that there are neither rewards for service providers nor punishments to defaulters. The paper reports that random checks showed that 29 to 67 percent of doctors were absent.

As the Planning Commission's midterm appraisal of the 10th Plan had observed, "when people first seek treatment, an estimated 70-85 percent visit a private sector provider for their health care needs". Morevoer, "the poor avail of the costlier services provided by the private practitioner, even when they have access to subsidised or free public health care, due to reasons of distance, but most importantly, on account of the unpredictable availability and very low quality of health care services provided by the rural public primary health sector."

The paper comes up with some innovative solutions. For example, it proposes education vouchers as "a more powerful method of enforcing accountability is to enable parents to choose between the schools where they will send their children. Enabling people to choose between available public or private schools (by giving them suitable entitlements reimbursable to the school) and thus creating competetion among schools could be considered."

Similarly the approach paper suggests a voucher scheme for secondary school students since 58 percent of secondary schools are private aided or unaided. Vouchers would allow students to go to private schools in areas where they exist.

The paper proposes that in order to energise health systems for improving health outcomes, innovative finacing mechanisms are critical. "Publicly supplied health care depends on how health care providers are paid. Providers should be paid only if they actually perform a service." It suggests that one way out may be to empower Panchayati Raj institutions to manage, administer and be accountable for health services in community levels.

It is clear from the approach paper that the problem is not lack of funding, but lack of accountability. That institutional reform, and not higher spending, is the key to better health and education. So, unless the Planning Commission promises that will not spend a single rupee more on the systems that it has demonstrated do not work, there is no justification for shifting FRBM targets.

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