The hidden cost of free lunches 

A crowd at an election rally in Uttar Pradesh. (Image Source: AP/File photo)

The prime minister has set the cat among the pigeons, with his fusillade against election freebies while inaugurating the Bundelkhand expressway. He said the culture of garnering votes by promising freebies harms the country’s economic development and warned the youth, ‘Your present will be lost and your future pushed into darkness.’ Those who believe in distributing freebies, he said, would never build infrastructure, sorely needed for securing the country’s future.

That little speech succinctly lays out the rationale against populism---it promises instant gratification, at the cost of future penury. Predictably, the speech drew the ire of AAP supremo Arvind Kejriwal, who defended his trademark policy of giving away free power. His promise of giving 300 units of free power to each household if his party wins the Gujarat elections is estimated to cost the state Rs 8700 crore a year. It is policies such as these that have resulted, over the years, in the total outstanding amount due to power generation and distribution companies by state governments ballooning to an astronomical Rs 2,40,710 crore. Who would want to invest in such a sector? Even more importantly, policies such as these and the cross-subsidisation of household power consumption push up electricity prices for commercial and industrial users, eroding their competitiveness. An OECD report in 2019 ranked India 108^th out of 141 economies on the quality of electricity supply.

While free power may be the most egregious example, the malaise affects the entire economy. What is the rationale, for example, of not taxing agricultural incomes? Why does the sugar sector bristle with subsidies and regulated prices? The country may be staring at a catastrophe because of a disinclination to price water at its true cost. We have seen how lopsided fertiliser subsidies have affected the soil. There are many such examples, which do far more damage than the run-of-the-mill promises of free laptops, TV sets, mangalsutras and even goats, which have been a regular sideshow of recent elections.

Kejriwal reacted to the PM’s warning on freebies by asserting that free education and health services are not freebies and that the Delhi budget can afford giving free power. The argument here is that if a state can afford it, there’s no harm in giving subsidies. But there’s always a cost---the opportunity cost of alternative uses for the funds being given away as subsidies. It is to this opportunity cost that the prime minister referred to when he said those who distributed freebies did not build expressways.

Simply put, no nation has ever consumed its way to greatness. Even a casual look at the East Asian nations that have achieved strong growth indicates that their investment to GDP ratios were very high during their growth spurts. This was true of Japan and South Korea earlier and is true of China now. That is why infrastructure growth is so important. Capital accumulation is the precondition for growth, no matter what the economic system. England did it through the enclosure of common land and by exploiting its colonies. The erstwhile Soviet Union expropriated surpluses from the kulaks. It was Deng Xiaoping’s acknowledgment that ‘some people will get rich first’ that led to the long boom in China---that country has one of the lowest private consumption to GDP ratios. You have to grow the pie before you can redistribute it.

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Manas Chakravarty

Group Consulting Editor|Moneycontrol

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True, not every measure of social support can be labelled a freebie. Those that help build human capital, such as spending on education and health and skilling and training programmes aren’t freebies. Some measures are needed to attract capital to our shores, or to make our industry competitive. And there will always be a need for a safety net for the indigent. The problem arises when the government is unable to manage all the competing demands from various groups, resulting in a bloated fiscal deficit. You have to cut your coat according to your cloth.

South Asia already has a scary example of the perils of populism---Sri Lanka. The warning signs were clear long ago. Here’s what an IMF report had to say in 2005: ‘Very few countries have averaged higher fiscal deficits than Sri Lanka over the last 25 years. High deficits have raised the level of public debt to more than 100 percent of GDP, hampering private investment by raising expectations of higher future taxes and heightening macroeconomic risks. Interest payments have become the largest expenditure item in the government budget and have crowded out public investment.’

India is no Sri Lanka. But Moody’s pointed out last year that India’s government debt burden has increased substantially and it expects it to stabilise at 91 per cent of GDP, which is well above the 48 per cent median level for peers rated Baa. It adds that interest payments are 26 per cent of government revenues, the highest among Baa rated peers. It is the weak fiscal situation that is holding back India’s credit rating.

Plainly concerned about the impact of poll promises, the Supreme Court has now decided to set up an expert group with members from the Election Commission, RBI, the Finance Commission, Niti Aayog and political parties to suggest ways and means of solving the problem. One way of doing it is to compute the cost of every poll promise, as is being done in Australia, and publicising it. S Chandrasekhar, professor at the Indira Gandhi Institute of Development & Research (IGIDR) wrote, ‘political parties should be required to offer an explanation of how they will fund their poll promises even if it is based only on back of the envelope calculations.’

Will such a move work in India’s federal and democratic set-up? In India, irresponsible political parties, especially regional parties, may well give short shrift to any recommendations by an expert group. And even if they are required to give an account of the costs of the freebies and their funding, what is to prevent them from fudging the figures?

Commentators frequently point out that late developing nations had their growth spurts under authoritarian systems, which could resist the demands for redistribution. But even authoritarian regimes have their pressures. Chinese President Xi Jinping, in his speech last December at the annual Central Economic Work Conference, had railed against ‘welfarism’. He said: ‘We must improve the system and institutions of public service policies and promote common prosperity, rather than falling into the trap of "welfarism".’ He added, ‘Raising welfare is easy while cutting it is another story. Moreover, "welfarism" beyond a country's capability is not sustainable, which would inevitably cause severe economic and political problems!’ That is not very different from what Prime Minister Narendra Modi is saying.

The subject of poll freebies should be a matter of continuous debate and discussion, so that pressure is exerted on political parties to agree on a common minimum programme to limit freebies, perhaps as a percentage of the state budget. There is no need for pessimism. After all, we have made progress on many contentious issues in recent times, including FRBM norms for states, GST, privatisation, and labour laws, to mention a few. And to take one heartening example, we not only got rid of the fuel subsidy, but were also able to make hefty increases in excise duty on fuel, with few protests. The reform process in a democracy may be slow, but it also has greater legitimacy.