Cash transfers will work, if…

…there are economic reforms, astute targeting and restructuring of government

Cash transfers are here. Okay, some cash transfers will be here in some districts for some people early next year, after which the programme will be implemented across the country. No one is in any doubt that this is a pre-election move by the Congress party—it was announced in the party headquarters and not a government office (See Soma Banerjee’s article in Economic Times). It is an election sop. However, unlike loan waivers and the national rural employment guarantee scheme, it is not a bad one. It can even be a good one provided certain important conditions are met.

But first, cash transfers are based on sound economic rationale. They are generally less inefficient than subsidies for goods and services. Also, because they put cash in the hands of the recipients, they are more respectful of individual freedoms and choices. Whether they are also effective in alleviating poverty is another question. Even so, to the extent that they are an improvement over the status quo—by reducing bureaucratic processes, lowering corruption and shortening delays—we should cautiously welcome the introduction of the cash transfer scheme.

There is some debate on why cash transfers work. In the case of conditional cash transfers—where the cash is allocated for specific purposes like education, food, fuel etc—there is debate as to whether it is the conditions that work or the cash. Abhijeet Banerjee and Esther Duflo, economists whose work this blogger respects, believe in the latter: that it’s the cash that makes the impact. (More at TechSangam)

It might sound heretical, but the best scheme might involve ending all subsidies in kind, closing down as many “welfare” ministries and departments, and using the funds to give unconditional cash transfers to the needy. Give the needy cash, respect their individual freedom and just let them spend it as they wish. (See this post for why the old, corrupt political economy of poverty alleviation resists this.)

We are, of course, far from this goal. Only “the benefits of 29 welfare schemes of the government would now be directly transferred to beneficiaries in 51 districts starting January in a pilot programme and then will be extended to 18 states from April.” A total of 42 schemes have been identified for the cash transfer programme. These exclude the big ticket ones—food and fertiliser subsidies—but might include some fuel subsidies. Whether this is intentional, compulsion or both, the impact will be limited. Despite the hoopla in the headlines, it’s not a game-changer. But it can be one, if accompanied by other policy changes.

First, as warned and subsequently noticed in the case of rural employment guarantee, merely putting more cash into the hands of people without doing anything to make the supply competitive will cause prices to rise. Inflation can eat into the higher incomes, especially if they are in the form of cash, undermining the effectiveness of cash transfers. So how does one make supply competitive? By liberalising land, labour and capital regulations. By completing roads, railways, airports. By breaking barriers to inter-state and intra-state commerce. By liberalising education and agriculture. In other words, we need Reforms 2.0 before we can expect cash transfers to have the desired effect. The UPA government’s commitment to the reform agenda is much weaker than its enthusiasm for entitlements and transfers.

Second, it is necessary to target the transfers correctly. In a diverse society where communities are sensitive to relative gains, this is particularly hard. Exercises to identify the recipients, include those who qualify and exclude those who don’t, and to keep this list updated are very expensive, riddled with inefficiencies and fraught with political controversy. With a degree of flippancy, we could argue that making the scheme universal might save a lot of these headaches. Let everyone from Mukeshbhai to the poorest person in the country receive the same cash amount from the government. Let the “inconvenience factor”—for instance, a requirement to physically queue up at a government office every three months to revalidate the cash transfer account—determine who avails of the facility. The Aadhaar UID could then be used as a tracking mechanism rather than a filtering one. We are far from this, and as Bibek Debroy points out on his ET blog, targeting will be a significant problem.

Third, and perhaps the most difficult one, is that the efficiencies realised through a programme like cash transfers must register in terms of lower government expenditure and, all else remaining the same, to lower taxes. This calls for a radical review of subsidies and transfer almost all of them into the cash transfer programme. It calls for the pruning of ministries and departments that currently administer subsidies. Few governments have the stomach for this kind of overhauling of government—the UPA government certainly doesn’t—but to not do this would be to abandon the real payoffs.

Finally, every spending programme must come with a sunset clause. Cash transfers must be reviewed every few years to assess whether they are still required, and automatically lapse if not renewed. Not doing so presumes that policymakers cannot conceive of a time when a substantial number of Indians will no longer be poor. This is defeatism.

So, for cash transfers to work in the national interest, they must be accompanied by broad economic reforms, astute targeting and restructuring the government. From what has been announced by the UPA government, there is little evidence that the scheme only aims for anything more than limited efficiency gains in welfare disbursements. The Congress party evidently believes that this is sufficient to attain its electoral objectives.

Tailpiece: The final examination of Takshashila’s GCPP programme‘s January 2012 term asked students to design a programme “to support the country’s needy” (more details in the question paper). A few students proposed cash transfer programmes. You’ll find summaries of two of the responses on Logos, Takshashila’s public policy network blog.