Pathology of Redistributive Transfers in India
What is Redistributive transfer?
Redistributive Resource Transfers (RRT)— is gross devolution adjusted for some benchmark for the normal resources a state can expect to receive, which we define as the state’s share in aggregate gross domestic product (or alternatively as a state’s share in own tax revenues).
Difference between “Aid” and “RRT”
- RRT are intra-country transfers and do not add up to the overall national disposable income like foreign aid does.
- The donor-recipient relationship is also different because states benefiting from transfers are part of the national governance structures that determine them.
Downsides of Aid
- Aid perpetuates resource dependency, since revenues are being provided from outside, recipient countries may fail to or have little incentive to develop their own tax bases or their institutions. And it is institutions that have been found to be critical for growth, much more than overall resource availability.
- Another potential downside of aid is that it could trigger the “Dutch disease”, named after the impact that discovery of natural gas in the North Sea had on the domestic economy in the Netherlands. This windfall caused the real exchange rate to appreciate as the extra income was spent domestically, pushing up the price of non-tradables, such as services geared to the local economy. The higher prices for services then eroded profitability in export and import-competing industries, de-industrializing the economy, with the share of manufacturing in the economy falling.
Do we see similar consequences within India due to RRT?
Higher RRT seem to be associated with:
- Lower per capita consumption
- Lower gross state domestic product (GSDP) growth
- Lower fiscal effort (defined as the share of own tax revenue in GSDP)
- Smaller share of manufacturing in GSDP, and
- Weaker governance.
There is suggestive evidence of causality (from RRT to economic outcomes and governance). The results indicate that all the pathologies associated with foreign “aid” appear to manifest in the context of intra-country transfers too.
However, there are a few states which are exceptions though, for example, Tripura with respect to per capita GSDP growth or Mizoram with regard to governance.
If the evidence suggests an “RRT curse”, what are the policy implications?
The “solution” cannot be to dispense with RRT altogether, since in a federal system the Centre must play a redistributive role because it will always have to redirect resources to under-developed states. Rather, the Centre will need to ensure that the resources it redistributes are used more productively.
- One possibility is that that the “RRT curse” originates from poor connectivity and poor infrastructure—physical, financial and digital—that most of these states, and certainly the North-Eastern states, suffer from.
- Enhancing connectivity on a war footing (as the government has attempted for financial inclusion with the Pradhan Mantri Jan Dhan Yojana, or PMJDY, expediting the optical fibre network, etc.) will have a moderating effect.
Beyond facilitating connectivity, there are a number of ways in which the architecture of redistributive resource flows could be modified.
- Direct flows to households: Redirect a quantum of RRT directly to households as part of a universal basic income (UBI) scheme in relevant states. Targeting issues plague existing development interventions and transfers directly to households could eliminate a large majority of these problems.
- Performance-contingent transfers:Finance Commissions could revert to the practice of the 13th finance commission of explicitly conditioning transfers on the tax effort of states, and perhaps to an even greater extent.
- Governance-contingent transfers:To encourage better governance, the fund transfer mechanism could explicitly include a few monitorable institutional indicators as criteria for resource transfers.
In conclusion, large sums of redistributed resources—can create pathologies, even in democratic India. Recognizing and responding to them creatively will be important to learn the lessons of development experience in India and around the world.