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The poverty of economic policy

Print edition : Mar 16, 2002 T+T-

Instead of giving a thrust to the economy by initiating programmes for rural development, the Budget opts for the problem-ridden way of public investment in infrastructure.

CONSIDER this. The government embarks on a large food-cum-cash for work programme in rural India. The food component comes from the Food Corporation of India (FCI) which currently has 60 million tonnes of foodgrain stocks of which nearly 40 million constitute surplus stocks. The cash component is spent by the beneficiaries to purchase simple industrial consumer goods. The consumer goods sector is currently facing a recession, but the demand stimulus increases their output. Likewise, the non-wage component of such a programme creates demand for a variety of industrial goods whose output increases. With the increase in output in these industrial sectors the government's tax revenue increases as well, so that much of the original expenditure undertaken on the rural programme flows back to the government itself, either to the FCI or to the exchequer in the form of additional taxes. There is, to be sure, some increase in the fiscal deficit but this is not a matter for worry, since it is only a fraction of the expenditure on the programme. And in any case, this fiscal deficit has been used to finance capital formation as the end-result of the programme. And fiscal deficit to finance investment arouses less ire even from dyed-in-the-wool orthodox economists.

On the other hand, on the positive side there has been a reduction in food stocks, clearing the ground for a continuation of procurement operations to the benefit of the peasantry; there has been an increase in rural employment and a reduction in rural poverty and hunger; there has been a demand stimulus to industry and an alleviation of industrial recession (with its further multiplier effects including greater investment demand owing to industrial recovery); and there has been capital formation, an increase in public assets in rural India in the form of school buildings, or roads, or bunds, or irrigation channels, which have great significance for improving production potential and the quality of life. And all this has been achieved without the slightest danger of inflation and without imposing any additional taxes.

THIS is no idle day-dreaming. Such a course was available to Yashwant Sinha when he prepared this year's Budget. Had he taken this course he could have changed the face of rural India at no cost to anyone. But he did not take it. Why he did not is a matter that need not detain us here. Perhaps he and his team are too much the prisoners of other people's theory, "the other people" in this instance belonging to Washington D.C. Perhaps he could not face the ire of the rural rich, for whom any improvement in the lot of the rural poor (even when not paid for out of taxes levied on them) poses a threat to social power. Anyway, whatever the reason, he did not pursue this course. What then, is the course that he did pursue to break out of the recession and stagnation that is engulfing the Indian economy?

His strategy, he claims, is to impart a demand stimulus to the economy through an increase in public investment in infrastructure. The Central Plan outlay on power, roads, and Railways would go up by 22, 39 and 23 per cent respectively, and the total Central Plan outlay is expected to go up by 12.5 per cent over the revised estimates for 2001-02. Instead of imparting a thrust to the economy through rural development (Central Plan Outlay for this Ministry is supposed to increase by a mere Rs.104 crores which is less than 1 per cent of the revised estimate for 2001-02), he claims to be doing so through public investment in infrastructure.

There are, however, at least three problems with this claim. First, the Budget's own contribution to the proposed increase in public investment in these three infrastructure sectors is in fact negative. Out of the Rs.16,182-crore increase in Central Plan outlay, Rs.6,595 crores is to come from the Budget while Rs.9,587 crores are to come from the internal and extra-budgetary resources of the public sector. But in the three core infrastructure areas mentioned, budgetary support has actually gone down by Rs.400 crores. So the thrust that Yashwant Sinha is talking about would have to come from public sector enterprises fending for themselves.

Now, there is a peculiar contradiction here. On the one hand the government is insisting on public sector enterprises being profit-conscious, being run on commercial lines, and so on. On the other hand, in the midst of a recession where the tendency of a commercially-run enterprise would be to cut down on investment (which is why recessions get spontaneously compounded in capitalist economies), the government is asking the same enterprises to undertake huge investments, unmindful of the state of demand and prospective profit and financed to a significant extent by borrowing, to pull the economy out of recession. Given these conflicting signals, to be both profit-oriented and altruistic at the same time, it is more than likely that these Plan outlay targets would not even be met. And perhaps the government does not even care about these conflicting signals because it does not expect these targets to be met anyway. In 2001-02, after all, there was a shortfall of Rs.2,325 crores in Central Plan outlay (revised estimates) compared to the budget estimates.

A further reason why a shortfall seems likely is that the tax revenue figures represent gross over-estimates. In 2001-02, there was a shortfall of as much as Rs.30,000 crores in gross tax revenue compared to the budget estimates, of which the States' share was Rs.10,000 crores. Given such a squeeze on their collective finances it is hardly surprising that so many State governments are in acute financial crisis. Such shortfall characterised virtually every major tax source, but was most pronounced in the case of customs duties where it amounted to Rs.11,652 crores.

A number of factors went into its making: domestic recession which had a restraining effect on imports and hence customs revenue, reduction in tariff rates, and lower unit values of imports on account of world recession and dumping on the Indian market. The government, oddly enough, has gone in for a further reduction in tariff rates in this Budget, which can only compound the recession and which has come ironically at a time when the U.S., the leader of the capitalist world, is imposing import tariffs on steel to help its own crisis-afflicted steel industry (which, moreover, would have potentially damaging consequences for India). Anyway, given this tariff reduction, since several of the other factors mentioned above are unlikely to change much during the coming year, customs revenue is unlikely to show any noticeable increase.

As for other taxes, their revenue estimates assume a resumption of high industrial growth. Any higher industrial growth, however, is itself predicated on larger government investment which has to be financed inter alia from higher tax revenue. There is therefore a sort of chicken and egg problem here which can as well yield a low-level equilibrium of continuing stagnation and recession, low taxes, low internal resources of public enterprises and low public investment. In short, the shaky empirical foundations of Yashwant Sinha's strategy rob it of all credibility.

The second problem with this strategy is that even if public investment in these core sectors is kept up in order to stimulate the economy come hell or high water, its impact on the rest of the economy may not amount to much, since a significant part of the demand generated by such investment is likely to leak out abroad in the form of imports, and this is especially true because of the cut in import duties. In the power sector, for instance, since Central Plan outlay is to be financed out of extra-budgetary sources, it is likely that the government would approach foreign donors to set up power capacity. They invariably insist on tying their loans (even when these take the form of outright grants) to equipment purchase from their countries. In such a case, a large increase in investment in the power sector would hardly generate much multiplier effects on the domestic economy. And the same, in varying degrees, may be true of the other infrastructure sectors as well. (By contrast, government outlay on a rural employment programme is hardly likely to generate, directly or indirectly, any noticeable import demand).

The third problem with this strategy is that, whether or not it is successful, it leaves untouched the entire problem of burgeoning foodgrain stocks. A solution to this has to be found if the system of procurement is to continue at all. While Sinha did not spell out his ideas on the subject, preferring to wait till a Committee set up on the question gives its recommendations, there were hints that the government wishes to wash its hands of procurement operations altogether. In any case, several economists have been advocating this - which would be such an ill-advised move that some discussion on it is in order.

First of all, there are those who argue that India is "over-producing" foodgrains, that the fact of lower offtake, compared to output, is a reflection not of reduced purchasing power in the hands of the rural poor, but of their diversifying their consumption away from foodgrains.

There are two obvious flaws in this argument: one, dietary diversification, even when it means that the direct consumption of foodgrains does not increase as people become better off, invariably entails an increase in the direct-cum-indirect consumption of foodgrains. There may be a diversification of consumption from grain to, say poultry, but then grain is fed to the poultry, so that the total (direct and indirect) grain consumption increases per capita with such diversification. This is why in the U.S., per capita grain consumption (gross availability) is 888.6 kg a year (the average for 1992 to 1994), as compared to 202.3 kg in India (for the same period on the same basis). The idea of dietary diversification resulting in a reduction in total demand for foodgrains is simply wrong.

Two, per capita calorie intake appears to be going down among rural households in all States (except, interestingly, in Kerala and West Bengal); and voluntary, choice-dictated dietary diversification away from foodgrains is not compatible with such reduction in calorie intake. It follows then that the argument that India is producing "too much" foodgrains, relative not just to purchasing power but to needs, and that this is because of the system of procurement which, by providing assured markets at remunerative prices, makes such production of unwanted foodgrains profitable, is plain wrong.

Then there are those who argue that the demand for foodgrains would increase provided prices are brought down. And the reason for prices being high is the high level of procurement prices, enforced by the "kulak lobby". This lobby would want the procurement system to go - for the sake of the rural poor. It is curious, however, that those who argue along these lines never ask for greater purchasing power to be put in the hands of the rural poor, which is an alternative measure that would achieve the same end (of increasing the consumption of the poor instead of adding to foodgrain stocks) without dismantling the procurement system. After all, real purchasing power can be increased either by reducing prices at given money incomes or by increasing money incomes at given prices; why is the former, which would necessarily entail hardships for the peasantry at a time of declining world prices and which would disrupt the food self-sufficiency (of sorts) achieved with so much difficulty, privileged over the latter, to a point where the latter does not even find any mention in their argument? (It was argued for a while that both options of increasing purchasing power are feasible, but the former is the more efficacious of the two. But this is so palpably incorrect, assuming as it does a high price elasticity of demand but a low income elasticity of demand for food, which cannot be true for a basic necessity, that this argument has been quietly dropped of late.)

No matter how we look at it, the only way that the country can move forward without destroying the food economy built up painstakingly over the last three decades is by putting larger purchasing power in the hands of the rural poor. Yashwant Sinha has not done it. What he has done amounts to precious little.

Prabhat Patnaik is Professor of Economics, Jawaharlal Nehru University,New Delhi.