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.

Double talk on double-digit

India doesn’t need to buy peace from its neighbours to sustain economic growth

At a talk I gave recently, one person asked if the numerous crises in India’s immediate neighbourhood limit India’s growth. This was some time after Prime Minister Manmohan Singh, at a press conference in May, asserted that “India would be unable to realise its full economic potential if it couldn’t reduce tensions with its neighbours, especially Pakistan”.

“Not at the moment, and not for the foreseeable future” I replied, “because the biggest bottlenecks to sustainable economic growth are domestic.” Only after the most important reforms—creating a national common market, unshackling agriculture, liberalising labour laws and fixing the education system—run their course might the situation in the neighbourhood begin to matter.

In a recent paper demographics and India’s labour force, Tushar Poddar and Pragyan Deb of Goldman Sachs estimate that they see the Indian economy growing at a base rate of 8% per annum. With the required reforms, the growth rate will increase to 9%. With wrong policies, there is a risk that the growth rate will fall to 6.5%. [See recent articles by Niranjan Rajadhyaksha & V Anantha Nageswaran for a discussion on sustaining high growth rates].

The neighbourhood doesn’t register much in these assessments. In fact, Dr Singh himself concedes as much. “A number of inherent strengths in the country’s economy,” he said this month “can contribute to rapid growth in the future and they should be harnessed to push up economic growth to double digits.” In other words, Dr Singh the economist contradicts Dr Singh the geopolitical strategist.

The prime minister’s concession underlines the simple fact the most brazen of Pakistan’s skulduggeries are but a pimple on the posterior of the India economy. You don’t need to have grand “composite dialogues” with Pakistan’s impotent politicians to sustain India’s economic growth.

On the contrary, the question for India’s neighbours is whether or not they want to benefit from India’s growth process? It’s their decision. Sri Lanka and now Bangladesh appear to have embarked on trajectories that make the most out of opportunities provided by both India and China. Pakistan—perhaps because its unaccountable elite are buttressed by liberal Western aid—is unconcerned with improving the lot of its own people. That is its own problem. This does not mean it is not in India’s interests to improve trade with its crisis-ridden neighbour. It only means that it won’t hurt the Indian economy much if it doesn’t happen.

Once the Indian economy exhausts all the potential from the necessary next wave of reforms the condition of the neighbourhood might begin to impose constraints on its further growth. That point is at least two decades away. And it is by no means certain that it’ll matter even then, for it is possible that the neighbourhood will matter even less.

The Sonia Gandhi-led Congress Party is equivocal (okay, very unwilling) on using its political capital to carry out the reforms that are necessary for sustainable double-digit growth. Dr Singh is committed to losing his political capital on pursuing talks with Pakistan that are unnecessary for that purpose. Don’t be fooled.

From the archives: The Reagan Parallel, June 2004

Credit crisis could benefit India

On the virtues of making haste slowly

V Anantha Nageswaran would smile when he sees the Economist Intelligence Unit concede that:

Ironically, the current global situation is also making India’s measured pace of economic reform look wiser than before. At a time when Western countries are frantically nationalising banking assets, the Indian government’s reluctance to sell more than 49% in its state-owned banks—which control some 70% of banking assets—now seems reassuring. In addition, India has not yet introduced full capital-account convertibility, which protects its currency, while its careful control of foreign borrowings by domestic companies limits dependence on the global financial system. Regulators have also periodically introduced curbs to slow the formation of potential asset bubbles, such as higher provisioning and prudential requirements on real-estate lending.

The EIU believes that while there would be some short-term worries, Indian companies are likely to use the crisis to make overseas acquisitions.