Government pushing welfare measures more than reforms

Financial Express, 24 July 2011

India will complete twenty years of liberalisation today. The removal of the licence permit raj was done with hope that it would usher in a market economy. The focus of the government in the last few years has been quite different. In contrast to reforms that were meant to help India turn into a market economy, the goverment has turned to providing benefits to the people. Both are meant to reduce poverty but the basic philosophy of the two approaches is quite different. While the former was meant to increase the pie, the present approach focussing not on growing but on redistributing the pie.

Can India affort this new approach? Are we rich enough to focus on redistribution? Will the fiscal cost of welfare programmes bring in a crisis?

These are serious concerns today when a few years of fast growth seem to have convinced the government that now it can turn towards large welfare programs. It has been seen that countries with low per capita income of USD 1000, such as India, have tax collection to domestic production ratios (Tax/GDP) of less than 20 percent. It is only when a country's per capita income rises to about 10 times as much, that the government is able to collect more than 20 percent of domestic production in taxes. A large part of the Indian economy is in the informal sector. There is little participation in production chains where taxes need to be paid. Agricultural income is not taxed. Consequently, the developing country average for tax payments is 18 percent. This is roughly India's tax GDP ratio, when we combine central, state and local governments.

While resources can be raised by disinvestment or by selling spectrum, reducing subsidies and increasing efficiency in the immediate context, the tax to GDP ratio cannot be expected to rise unless the structure of the economy changes adequately. This has been seen to happen in the rest of the world when income levels are at about USD 10,000 per capita.

The above argument, as Vijay Kelkar and Ajay Shah point out in a recent paper, implies that the government needs to focus on higher GDP growth.

The focus on GDP growth needs to be put on the expenditure side as well. Faced with a trade-off between spending on building highways and bailing out loss making public sector enterprises in competitive markets, the former needs to take a clear precedence. Further, there are a number of issues including foreign investment, infrastructure, taxes, and so on, for which a laundry list of reforms is available.

What India is seeing today is not as much a lack of reform, as a new philosophy. The Congress today emphasises welfare programmes through various rights such as to employment, education, food etc which are redistributive in nature. They make people dependent on the state, rather than push the process of making India a well functioning market economy forward.

These benefits are enacted into laws creating fiscal liabilities for the government for the years to come. There appears to be little concern about the Indian government is going to meet these liablities. If GDP growth falls, as it well could like in Europe with the labour force becoming increasingly depending on doles from the goverment, it could well mean that India could rapidly fall into a debt trap. High inflation, large deficits and slow growth is one scenario that a country with such policies have seen to slip into. It takes a very long time after that, for example in the case of Brazil, to then come out of it. This is a risk the present reform strategy of the government suffers from.

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