Freebies are a passport to fiscal disaster

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Context: The strength of the Centre in India lies in the strength of the states. Hence, the macroeconomic stability of the Union is contingent on the macroeconomic stability of both the Centre and states.

It is in this context that the chairperson of the 15th Finance Commission, NK Singh, discusses the political culture of freebies in India, its dangers and why aiming for a higher economic growth rate is the way forward.

He explicitly states that both the economics and politics of freebies are deeply flawed, and is a race to the bottom.

He writes that we must dread the thought of replicating the culture of competitive freebie politics in India.

Understanding difference b/w freebies and public goods expenditure

There is a need to distinguish between the concept of freebies versus expenditure on public goods having overall benefits. All over the world, these are considered to be desirable expenditures.

Examples: Strengthening and deepening of the public distribution system, employment guarantee schemes, support to education and enhanced outlays for health, particularly during the pandemic.

Why freebies are not desirable in the long run?

1]. Impact on macroeconomic stability – The politics of freebies distorts expenditure priorities. Outlays are being concentrated on subsidies of one kind or the other. This impacts the fiscal sustainability of states which are already debt-stressed.

– Example: In the case of Punjab, it is speculated that the promise of freebies might cost around Rs 17,000 crore for their implementation. The debt-to-GDP ratio of Punjab is already at 53.3% for 2021-22, which would worsen on account of these new measures.

2]. Distortion of expenditure priority: Take, for instance, the change to the new contributory pension scheme from the old scheme, which had a fixed return.

– Rajasthan announced that it would revert to the old pension scheme.  The pension and salary revenues of Rajasthan amount to 56% of its tax and non-tax revenues. Thus, 6 per cent of the population, which is made up of civil servants, stands to benefit from 56% of the state’s revenues. This can not only cause issues like intergenerational inequality, but also affect the broader principles of equity and morality.

3]. The issue of intergenerational equity leads to greater social inequalities because of expenditure priorities being distorted away from growth-enhancing items.

4]. Movement away from the environment: When we talk of freebies, it is in the context of providing, for example, free power, or a certain quantum of free power, water and other kinds of consumption goods. This distracts outlays from environmental and sustainable growth, renewable energy and more efficient public transport systems.

5]. The distortion of agricultural priorities: This affects agricultural practices which do not depend on extensive use of water and fertilisers. The depleting supply of groundwater is an important issue to consider when speaking of freebies pertaining to free consumption goods and resources.

6]. Debilitating effect on the future of manufacturing: Freebies lower the quality and competitiveness of the manufacturing sector by detracting from efficient and competitive infrastructure enabling high-factor efficiencies in the manufacturing sector.

7]. Subnational bankruptcy: Freebies bring into question market differentiation between profligate and non-profligate states and whether we can have a recourse mechanism for subnational bankruptcy.

What is the way forward?

India must strive instead for a race to efficiency through democracy and federalism where states use their authority to harness innovative ideas and solutions to common problems which other states can emulate.

Source: This post is based on the article “Freebies are a passport to fiscal disaster” published in The Indian Express on 21st Apr 22.