The use and misuse of poverty lines

The undesirable consequences of using a macroeconomic indicator as a criterion for entitlement.

Earlier this week, the UPA government’s Planning Commission announced that there has been a significant reduction in poverty in India over the last decade—essentially, during the UPA’s two terms in office—from 37.2% in 2004-05 to 21.9% in 2011-12. In other words, while there were 407.1 million poor people in India in 2004-05, the number had come down to 269.3 million by last year. The Planning Commission uses the Tendulkar method (see Rathish Balakrishnan’s explainer on the brief history of poverty lines in India) but it is quite likely that poverty will show a decline regardless of the method adopted to measure it. This is good news.

What was meant to advertise the UPA government’s achievement has actually put it in a spot. How can the UPA government now justify providing deep, open-ended food subsidies to over 822 million people? Does subsidising food for the non-poor, at tremendous cost and contingent liability to the exchequer, have the same justification as delivering essential food to those who absolutely cannot afford it? Not quite. If the Opposition parties mount a political challenge along these lines, it is unlikely that the UPA’s dubious poverty arithmetic will prevail. If.

Let’s consider a broader issue. What is a poverty line good for? Whatever the formula used, a poverty line provides a useful estimate of the level of poverty in a population. How it changes tells us whether public policies are helping or hindering poverty alleviation. The rate of change allows us to compare—albeit in hindsight—which set of policies are more effective in raising incomes. As the Planning Commission’s figures show, poverty declined at an average rate of 0.74% between 1993-94 and 2004-05, and at 2.18% between 2004-05 to 2011-12. This correlates with the higher economic growth rates achieved in the 2000s compared to the 1990s. This is consistent with the empirical observation that economic growth lifts people out of poverty.

What the poverty line is not good for is as a selection tool to identify beneficiaries for entitlements. This is because it is practically impossible to estimate whether a particular person earns more or less than the given poverty line income. This fact is lost on many policymakers and intellectuals—just how does one assess whether a person earns less or more than Rs 33 a day? There are no objective methods to test and verify incomes—no financial records, salary slips, bank accounts and so on. So we are left with self-declaration. However, if people know that those deemed below the poverty line will receive benefits from the government, they are likely to declare themselves poor. To take one example, in 2006, 91% of the families in Karnataka state declared themselves below poverty line.

The Planning Commission can set up expert groups that propose formulas involving automatic exclusion, automatic inclusion and scoring indices. Such methods only create an illusion of accuracy while creating a political economy—read corruption and political patronage—for the procurement of Below Poverty Line (BPL) cards. Note also that once a person acquires a BPL card, she is BPL for life. Such is the bluntness of poverty line-based schemes that they presume that a person, once deemed poor, will remain poor for life. This makes the BPL card even more valuable.

Moreover, for the sake of argument, even if we assume that it is possible to perfectly assess incomes, is it sensible to deny an entitlement to a person earning Rs 34, because the poverty line is set at Rs 33? What about Rs 35? Rs 36? Where do we stop? Any number you pick is arbitrary.

What this means is that while poverty lines are useful as macroeconomic performance indicators, they are useless when used as ‘entitlement lines’. If budgets were infinite, we could live with the leakages and inefficiencies in the knowledge that those who really deserve assistance are not deprived. However, budgets are not infinite, which means that public funds end up in the hands of undeserving people, while there isn’t enough money for essential public goods like education, health, security, roads, electricity and communications. Look at the state of our government schools, hospitals, police stations and roads and ask why they are in such a decrepit condition. It is politically suicidal for any government to cut back on subsidies and entitlements. It is fairly easy, in comparison, to cut down on capital expenditure on public goods.

That’s why misusing the poverty line as an entitlement line is counterproductive—it slows down the rate at which poverty declines.

Related Link: My Takshashila colleague Pavan Srinath’s critique of the poverty line, on the INI Transition State blog.

India and international financial services

The opportunity in the crisis

In today’s DNA, Mukul Asher & Azad Singh Bali argue that it is an opportune moment for India to make a serious play in developing international financial services:

It may seem odd to stress the need for developing international financial services (IFS) during the fragile recovery from the global financial and economic crisis. The Reserve Bank of India (RBI) has argued with considerable justification that its conservative approach to liberalisation of the financial sector has significantly contributed to mitigating the macroeconomic impact of the current global crisis.

Nevertheless, diminished prospects of the current providers of IFS due to the crisis and subsequent rethinking of the appropriate role of finance; India’s own growth prospects; and its vision of emerging as a major economic power strongly suggest that this is an opportune time to develop IFS in India.

…The development of IFS in India primarily for domestic needs should be the first priority. This phase may last perhaps a decade. As India’s financial and capital markets acquire greater depth and size, in the subsequent phases, India could consider serving the needs of international clients and become a global financial centre. It is therefore clear that the policymakers and the stakeholders need to sustain their efforts and focus over a long term, and plan sequencing of this process carefully.[DNA]

By Invitation: Buy lots of mattresses

Wall Street woes

By V Anantha Nageswaran

In the last few months, financial markets had got used to the idea of the authorities conjuring up some solutions to problems in the US financial industry over the weekend and announcing it on Monday morning (Asian time) in time for the Asian stocks to open higher. This routine worked initially but when problems did not go away, the impact became rather muted.

Unfortunately for Lehman Brothers such a weekend solution did not arrive. Late on Sunday evening in the US it announced that it was going to declare bankruptcy. Wanting to avoid that fate, Merrill Lynch sold itself to Bank of America. Some called it tectonic shifts on Wall Street. Alan Greenspan, former chairman of the Federal Reserve said that America was facing once-in-a-century financial crisis. He should know better because he played no small role in creating it. Continue reading By Invitation: Buy lots of mattresses

From helping farmers to hurting them

Who gets hurt when grain exports are banned?

Swaminathan Iyer took the words out of this bloggers mouth. The UPA government, he writes “has suddenly shifted from protecting Indian farmers against cheap imports to protecting the consumer by cheapening imports”. He is referring to the ban on rice exports (which follow the export of wheat late last year, followed by the ban on export of maize and pulses).

The April 2008 issue of Pragati called for the government to free the farmers. The UPA government did just the opposite—far from allowing Indian farmers to benefit from selling their produce at record prices, the government is forcing them to sell at artificially low prices. So who is hurting the farmer? And why is silence replacing Sainath? And next year, when farmers find themselves unable to repay their loans, the UPA government—if it is in power at that time—will simply increase payouts and write-offs.

In the end the consumers pay the farmers: only the government gets itself into the equation causing unnecessary leakage and wastage.

Unnecessary? Why, isn’t it at least helping curb inflation? Not quite. As Mr Iyer explains:

The lesson is clear. Curbing exports is a form of national hoarding. If every country tries to hoard food, food prices will naturally rise. Governments would like to believe that hoarding by traders is terrible, whereas hoarding by governments promotes the public interest. But the impact on prices is exactly the same in both cases. Indeed, when governments start to hoard food out of panic, the panic itself stokes further inflationary fears.

That is why I am not optimistic about the Indian government’s anti-inflation package. The government thinks it is improving domestic supplies and hence bringing down prices. In fact the government is adding to the global hoarding problem, and stoking panic too. So, expect food inflation to keep rising in coming months. [TOI]

It’s all very well, you say, but what should the government do when poor people can’t afford food? Well, it should buy food grain at market prices and distribute it to those who need it. That way it will least distort the price signals that farmers receive and allow them to benefit from the good times. And by spending taxpayers’ money in a targeted manner—only the poor will enjoy cheap food—it will spend less. That is, if the government actually wanted to address the policy challenge, and not flail about paranoid of losing votes.