TCS Daily

So Much for Reform

By Christopher Lingle - April 6, 2006 12:00 AM

The release of India's central government budget sparked a veritable flood of ink and mixed commentary. Perhaps the public relations blitz at the World Economic Forum in Davos trumpeting New Delhi's commitment to reform led to mostly positive coverage.

But the reality of this budget, like so many that preceded it, is that populism trumps sound economic judgment. Much new spending is proposed without offering new initiatives to promote foreign investment, revive privatization or reduce the overall tax burdens.

In the end, India's famously-corrupt politicians and venal bureaucrats will have many new opportunities to line their own pockets while generating few tangible results to help the truly needy. As though this were not bad enough, financing the deficits to support greater venality and corruption involve a choice between the devil and the deep blue sea.

If the Reserve Bank of India inflates the money supply further, increased upward pressures on prices will continue. Otherwise increased government borrowing will lead to higher interest rates that "crowd out" private-sector investments and lead to slower economic growth rate with fewer new jobs.

Finance Minister Palaniappan Chidambaram set an impossible goal to reduce the fiscal gap without raising taxes on personal or corporate income or reducing government spending on infrastructure. Continued high economic growth might make this possible. However, government spending on education and health will rise while most subsidies on food, fertilizers and fuels remaining intact and all this without any more sales of state assets.

The poor policy choices and budgetary legerdemain of India's post-colonial governments focus on electoral payoffs instead of benefiting the poor and marginalized majority. Similar policies applied in the past have failed as evident in official data that indicate that about 23 percent of Indians are chronically poor.

The best/worst example of nonsensical populist palliatives is the National Rural Employment Guarantee Act (NREGB). The United Progressive Alliance government passed NREGB to provide "rights" of employment to millions of poor Indians.

Under this scheme, one adult member of every rural household would be guaranteed wage employment for unskilled manual work for at least 100 days a year. In a nod to India's pervasive Luddite traditions, provisions in the Act discourage the use of machines.

Receiving 60 rupees per day over 100 days amounts to about 500 rupees a month. While this will have a small effect on the conditions of most families, the increased fiscal costs could significantly reduce economic growth. As it is, the cost is estimated to be between 250 and 500 billion rupees (up to $10 billion) annually, or between 0.6 per cent of GDP and 1.5 per cent of GDP.

By focusing upon redistribution and creating new "rights" for rural households, this politically-inspired policy will not bring long-term improvements. Adding workers to the public payroll creates a new burden on taxpayers rather than a net gain for the economy.

For all the good intentions, the misguided notion that governments can create jobs should be consigned to history's dustbin. Schemes to promote employment growth through deficit spending were widely discredited by the end of the 1970s because of their role in the onset of stagflation.

Motivations behind such flawed logic are similar to economic policy choices guided by political considerations. Politicians and bureaucrats tend to make choices that generate short-run benefits with costs shifted to the future when they are less likely to be held accountable. Offering quick results with the impression of being actively engaged in problem-solving increases the likelihood of re-election even if eventual results are bad for the community.

Conversely, politicians almost always shun policies that generate short-run costs even if they might lead to substantial long-run benefits. This short-sightedness in policy choices is a serious deficiency that is endemic to the democratic process.

It would be bad enough if deficit spending on job creation was simply ineffective. But government-spending schemes that expand public-sector debt impose burdens on future generations that must pay higher taxes to pay for the debts incurred.

And government attempts to create jobs through deficit spending undermines or eliminates some future employment. As such, future generations confront higher tax burdens while having fewer job opportunities.

A better method for addressing employment growth is to undertake reforms that encourage entrepreneurial decision-making. New government spending does not change the incentive structures associated with tax codes or regulation that often inhibit entrepreneurial undertakings.

But economic and employment growth can be increased by eliminating excessive taxes or regulations that impede entrepreneurial initiatives. Removing such obstacles can lead to new business and employment opportunities.

When choices are made between political expediency and economic rationality, the wrong path is usually chosen. This is because politicians tend to protect or promote their own well-being instead of undertaking reforms to truly benefit their constituents. It is high time that the conditions of the Indian people are put ahead of the interests of the political class.

Christopher Lingle is Senior Fellow at the Centre for Civil Society in New Delhi.


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