The Plan expenditure fixation

Financial Express, 29 February 2008

Two holy cows are prominent in Indian debates about government expenditure. It is felt that capital expenditure by the government is desirable or essential to high GDP growth. It is felt that `plan expenditure' is somehow good and desirable, while `non-plan expenditure' is not "development-oriented" , is unworthy, and needs to be kept down. Both these propositions do not hold up to scrutiny. This has important implications for the future evolution of the FRBM.

Let's start with capital expenditure. The biggest value for central government capital expenditure was 7.77%, seen in 1986-87. The footprint of the public sector at the time was enormous. Out of total gross capital formation in the country of 25.55% of GDP, a full 13.14% (another all-time-high) of GDP was done by the public sector. In other words, in 1986-87, more than half of the investment of the country was controlled by the government and its various arms.

From these heights, the role of the public sector has declined sharply. In 2006-07, overall gross capital formation had risen to an astonishing 39.37% of GDP. Of this, just 8.49% was done by the public sector, and just 1.98% of GDP was central government capital expenditure.

In terms of results, in 1986-87, India was clocking roughly 5% trend growth, and was on the verge of a currency crisis. By 2006-07, India had moved up to 8% trend growth, with no crisis in sight. In 2006-07, we had high GDP growth, despite a small scale of public sector investment. In 1986-87, we had low GDP growth, despite a high scale of public sector investment. This demonstrates that high public investment is neither necessary nor sufficient for high GDP growth.

Given the inefficiency of public sector investment, and contrasted with the care with which the private sector husbands its resources, it is not surprising that a high public investment strategy did not work. Our acceleration of GDP growth over the last 20 years was assisted by the fact that government reduced its participation in the investment of the economy, going from over half of total capital formation to one fourth. We may well obtain a further acceleration in growth by further driving down public sector investment to below 5% of GDP, thus freeing up greater resources to be allocated and managed by the private sector which obtains a better bang for the buck when compared with public investment.

How can this perspective be reconciled with India's needs for the infrastructure of transportation and communications? Massive investments in roads, telecom, ports, airports, etc. can and should take place, but it is quite feasible to place these on the balance sheet of the private sector. There is an integral role for government in regulation and contracting of complex PPP projects for infrastructure. There may be a role for government in paying a small stream of `viability gap funding' (which would be a current expenditure and not a capital expenditure) to increase the interest of the private sector in undertaking infrastructure investments where traffic is uncertain. Once the contracting is achieved, the actual investment is best undertaken by private parties, who are more careful about handling resources for investment than the government.

This links up to the debate on the FRBM limits on the fiscal deficit versus the limits on the revenue deficit. At present, it is often felt that while revenue deficits are bad, it is okay for the government to run up deficits as long as the money is being used for capital expenditure. Central capital expenditure is now down to 2% of GDP, and half of this is defence hardware. It would be sensible to now abandon the distinction between the revenue deficit and fiscal deficit in the fiscal rule, and instead simply insist that the government must live within its means. In other words, FRBM must require a fiscal deficit of no worse than zero, except in an occasional calamity.

The second holy cow that merits examination is the beneficial or "developmental" nature of `plan expenditure' as opposed to the unhealthy overheads that are supposed to be in `non-plan expenditure'. Plan expenditure consists of expenditure in schemes that are processed through the planning commission.

Is "plan expenditure" a good thing? There is no evidence that money spent through the planning commission somehow delivers more bang for the buck. The planning commission has been complicit through several decades in the entire enterprise of massive government programs that have led to theft, wastage, corruption and recruitment of party workers as civil servants. In 1986-87, plan expenditure was at an all time high of 8.11% of GDP. This was slashed to 4.13% of GDP by 1998-99, which helped to set the stage for the ignition of high GDP growth in recent years. There is no reason to cherish plan expenditure.

The most fundamental role of a State lies in internal and external security. External security involves defence expenditures, which are non-plan expenditure. Internal security involves the police and judiciary, which are non-plan expenditure. Safety and law and order are the core tasks of the State. The Indian State has been floundering on these roles. The number one priority of the government should be to strengthen the police and the judiciary. This requires more non-plan expenditure. If getting to this requires reducing plan expenditure to below 3% of GDP, we should be quite comfortable with this.

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