Good vs bad subsidies: Time to differentiate between the two and focus on economic growth and employment

There has been an ongoing discussion recently regarding freebies and ‘revadi’ economics in India. This should not be a subject for debate given the extensive evidence which is available on the matter — both in India and across the world. But, unfortunately, the ongoing Sri Lanka crisis and concerns regarding weak fiscal health of states have prompted us to revisit this debate.

At the heart of this debate is what is termed as a freebie — and what is not. Alternatively, the essence of the debate could be simplified if one can formulate it as a debate between good and bad subsidies. I do not think that this is a debate anymore in economics — but it might continue to be a debate that occupies public policy and political space.

To add to the confusion, political leaders such as the Chief Minister of Delhi have deliberately added to confusion in public space by referring to free education and healthcare as “freebies” in an effort to insinuate that the Union government and the Supreme Court believe that such public services should not be provided for free. Nothing could be further from the truth and such an insinuation is not just irresponsible, but it is also unfortunate.

As a matter of fact, most Indian states do provide free education and healthcare, but the quality of it continues to remain poor. Delhi, despite the much hype, is no exception to the bad quality of these services. In fact, for much of the hype, the city has failed to create a workable model for the provisioning of these two basic public goods. If anything, Delhi should have been the easiest city to fix this given that the government of National Capital Territory does not have to focus on issues such as policing. Additionally, Delhi benefits from extensive healthcare and education facilities owned and operated by the Union government. Yet, the system crumbles are a testament to our misplaced governance priorities.

Investments in health and education that are geared towards improving outcomes are good investments in human capital. Nobody is alleging them to be freebies. Such expenditures are not revenue expenditures but are capital investments when they add to human capital.

Similarly, well designed and targeted subsidy programmes that focus on improving nutritional intake, supporting redistributive policies and other such programmes are also good subsidies. They are justified based on an economic rationale and can be evaluated against measurable outcomes. These measurable outcomes allow us to evaluate these policies and modify them from time to time to maximise social welfare.

But are all subsidy programmes desirable? No, badly designed subsidy programmes add to revenue expenditures that do not add any significant value to the state or its people. Moreover, many often ignore the opportunity costs associated with these programs.

Take the example of Delhi’s power subsidy. The subsidy is not targeted and therefore even with the restriction on the number of free units several households have obtained additional electricity meters to maximise their share of the subsidy. The subsidy is extended to the rich and poor alike which essentially makes it an inefficient form of subsidy. An alternative would be to simply transfer a fixed subsidy amount directly into the account of households identified as poor and vulnerable. This would reduce leakages and improve the overall efficiency of the programme.

But efficiency in terms of reduction of leakages is not the only issue. The other issue is the opportunity cost associated with running such a large subsidy programme. An obvious alternative to the existing programme is to use the subsidy amount for providing compensation to farmers in Punjab and prevent them from stubble burning. This alternative would reduce pollution faced by the citizens of Delhi and at the same time be instrumental in reducing the burden of diseases such as asthma, etc, which impose a much higher cost on citizens through healthcare expenditures than the cost of full payment of electricity dues.

In fact, it is perhaps due to the increased burden of subsidies that many states such as Delhi have been unable to spend on critical infrastructure needed in our urban centres— including that of modern hospitals and institutions of higher education. Delhi still has areas where water is supplied through tankers even as over 50 per cent households in rural India have access to piped water. This figure in 2019 was just 17 per cent. Therefore, subsidies do little to improve the access to these services while their cost keeps on increasing. These ever-increasing subsidies add to the deteriorating fiscal situation requiring levying additional taxes on citizens or creative accounting to understate the true extent of deficits.

More importantly, by distracting governance from resolving crucial challenges such as pollution to reducing it to ill-advised schemes such as odd-even or even electricity subsidies, Delhi has perhaps lost out in the race to acquire young talent. The consequence of this is yet to be felt on not just the growth prospects but also on the share of direct tax revenues as cities such as Bangalore overtake Delhi as India’s economic engine.

The politics of freebies suited India in the 1970s and the 1980s. It made sense during an era of scarcity but makes little sense in the 2020s when our politicians must be focused on generating economic growth and employment. That leading chief ministers are busy discussing subsidies and conflating it to be policies is just a sad reflection of our inability to correct past errors.

This is Part I of the two-part series on subsidies and freebies. The second article will focus on the problem with the Delhi model.

Karan Bhasin is a New York-based researcher who is pursuing PhD in Econometrics & Quantitative Economics. Views expressed are personal

Read all the Latest News, Trending News, Cricket News, Bollywood News,
India News and Entertainment News here. Follow us on Facebook, Twitter and Instagram.