Subsidies: bad economics, worse politics

Policymakers have once again failed to link good economics with good politics. Cutting inefficient subsidies is fine, but that should have been done without pushing price rise


Alam Srinivas | November 2, 2012

There is a new and ever-increasing buzz about economic reforms. The business community is excited, stock markets are ecstatic, and economists are elated with the government’s recent decisions to allow FDI in multi-brand retail and pension, and hike it in insurance. In a recent interview to the Economic Times, finance minister P Chidambaram said that these decisions, including the hike in diesel prices, “were such they could not have been put off any longer”.

Simultaneously, the critics have sharpened their knives. Their intention is to attack the government for its pro-market, but anti-people, announcements. However, in the high-pitched exchanges between the supporters and critics, the politics of economics, or the implications of coalition arithmetic, has been conveniently or deliberately forgotten. Now that the cabinet has approved 49% FDI in insurance and pension, can the minority government risk a vote on these bills in parliament?

Ironically, the same political misunderstanding is visible on discussions related to subsidies. The steps taken by the cabinet, pronouncements by Chidambaram, and recommendations by the Kelkar committee on fiscal consolidation indicate that ‘good politics’ has taken a back seat. Good economics, it seems, is only possible at the expense of the poor people and middle-class homes. To get the country back on the growth track demands an overall increase in food, fuel, and fertilizer prices.

Politics, in a sense, has been subsidised at the expense of economics. In the past few years, and specifically in the past few weeks, we have witnessed an emergence of the Subsidy Raj.

Battles over fiefdom
For years, governments have maintained that subsidies need to be better targeted. They should reach the people they are meant for, and one has to weed out leakages within the system. In the interview quoted earlier, Chidambaram reiterated that “we can’t wish away subsidies, but can improve their delivery.” Shockingly, it was Chidambaram who, as the home minister, tried to scuttle the Aadhaar (UID) project, which aimed to achieve the same objective, in a classic turf battle.

Initially, Aadhaar, under Nandan Nilekani, planned to collect data from 10 crore people and provide them with a unique number that could also be used to target subsidies. The number was raised to 20 crore, which was vehemently opposed by the home ministry, when Chidambaram was its head between 2008 and 2012. The reason: only the census had the expertise to collect such data, its national population register (NPR) to do it was under way, and there were security concerns with Aadhaar.

Finally, Nilekani and Chidambaram agreed to divide the work. While Aadhaar would target 6 crore people, the home ministry-census NPR project would collect information from a similar number. But the finance ministry has now initiated another biometric (or identification) scheme through the banks. At the same time, the post department has stated that it could distribute cash subsidies given its all-India network, and the labour and rural development ministries would like their own set of identifications.

Clearly, it is a matter of fiefdom. Supported by prime minister Manmohan Singh, Nilekani wants to emerge as the ‘information champion’. Both as the home minister and now as the finance minister, Chidambaram wants to control such a project. And the other junior ministers don’t want to give up their role in managing the subsidies. No one is really interested in finding a clear-cut solution.

Wars over cash transfers
In the ET interview, Chidambaram said that subsidies should be delivered directly to the beneficiaries through cash transfers. “The PM has now announced an authority for cash transfers and we have a timetable that we intend to push forward,” he added. What he didn’t mention was that several political wars were being fought to wrest control over this transfer mechanism. Chidambaram, Nilekani, chief ministers and national informatics centre (NIC) are active participants in them.

More importantly, the various pilot projects on cash transfers have revealed huge problems. They have highlighted that while the money would reach the recipient, it would not reduce corruption within the system. For example, consider the experiment to move the money into individual bank accounts under MNREGS. It was found that the real malaise was in the preparation of records related to how many workers worked for how many days on which projects.

Since such information was collected manually, the names of fictitious recipients, their number of working hours and fraudulent bank accounts were rampant under the scheme. Even genuine workers’ records were manipulated to overstate their working hours; the additional money received by them was then siphoned off by dishonest officials. The labourers who received the money were exploited by bank officers and middlemen when they went to withdraw money from their accounts.

Other problems cropped up. The government decided to pay fertilizer subsidies directly to the farmers instead of the manufacturers. As an interim measure, it said fertilizers would be priced at the market rate, but the subsidy component would be paid directly in cash to the thousands of retailers. A mobile software platform was developed on which the retailers would feed data about sales and inventories daily, and the money would be transferred to them accordingly.

Retailers found it quite taxing. First, they had to reduce their purchases as now they had to pay a higher market rate per bag. Hence, their inventories came down, which created its own set of problems as the sales of fertilizers are restricted to certain specific months during the year. Second, the mobile platform did not work as the software crashed regularly, and it had too many bugs. Thus, the retailers were unsure when they would finally receive the payments from the government.

Good economics, bad politics
There is little understanding among the policy makers on how to link good economics with good politics. For instance, most of the reforms related to subsidies entail an increase in prices. Diesel prices need to be hiked to reduce under-recoveries by oil marketing companies, urea prices have to go up, LPG cylinders have to be capped, and the central issue prices (CIP) of food items in the ration shops have to move northwards. No one talks of how subsidies can be reduced without such moves.

In fact, the Kelkar committee pointed out that “progressive reduction in food subsidy also needs to be achieved through reduction in administrative cost associated with economic cost. It may be pertinent to mention here that various overheads comprise nearly one-third of the consumer subsidy requirement of FCI (Food Corporation of India). It should be possible to effect reduction in food subsidy through more efficient food grain delivery mechanism…,” stated its report.

Similarly, it would have been better if the government had targeted sale of subsidised LPG cylinders to only the below the poverty line (BPL) families, and/or capped its usage for other households. Instead, it imposed a cap of six cylinders a year for all households. One could also argue that higher taxes on diesel automobiles would have been a better option to raise revenues, rather than hike diesel prices, which impacted every section – rich, middle-class and poor families.

Unfortunately, in the case of several other recommendations, even the Kelkar committee gets the politics wrong. For example, it suggested that the national food security bill, which is on its way, “may be appropriately phased taking into account the present difficult fiscal challenges”. Little did it realize that food security is partly a political issue, it has been promised by this government, which cannot renege on it in the 2013 budget, the last one before the scheduled 2014 general elections.

When it discussed the social impact of its measures, including the ones to reduce subsidies, the committee admitted that they will “have significant short-term negative impact on incomes and spending of all households”. It still asked the government to go ahead with them because “the consequences and pain would be even worse were these widely spread fiscal consolidation measures not pursued… (They) are thus essential to protect… all households from these worse impacts”.

The committee misunderstood that a government that has been criticised for a consistent price rise, especially of food items, in the past two years cannot afford to implement decisions that would further fuel inflation. Even the government forgot this bitter political truth, when it raised diesel prices and capped the usage of LPG cylinders. This too at a time when several state elections are around the corner, there are chances of a mid-term general election, and the entire opposition and some of the government allies have ganged up together to attack the government.

In such times, the policy makers have to pursue a path of good politics and good economics. Take a few steps, which are urgent, and which will hurt the people. But take a larger number of steps, which can indirectly reduce subsidies within a year’s time. Tackle the systemic problems urgently, and find immediate solutions to drastically improve efficiencies. To quote a Chinese proverb differently, the government needs to look at the moon, and not the finger pointing towards it.



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