Tuesday, October 23, 2007

The lie called subsidy

Whenever, as a matter of public policy, goods and services are sold for a price less than what it costs to produce and deliver, with the government bearing the loss, the resulting transaction is what we would generally call a ‘subsidy’. The problem with this term is that it is a little too academic and does not fully convey what is at stake. It is somewhat like referring to a murder as a ‘homicide.’

A subsidy is, to begin with, a lie. Because it conceals the truth from both the buyer who often pays far less than what he should, and from the seller who is compensated out of state funds. The buyer believes that what he is getting for a song is only worth so much. The seller, on the other hand, loses a powerful motive to innovate, improve efficiency and cut costs. Because, thanks to the subsidy, he has an assured market. In the erstwhile USSR, the price of bread was heavily subsided as a matter of state policy befitting the workers paradise. True, there was no hunger among its people. But farmers in the country who were allowed to tend to a small plot of their own land (even while working on a collective farm) ended up feeding bread to their pigs.

In a chaotic democracy like India, there is another aspect to this issue. More than subsidies going to the poorest and therefore to those who need it and deserve it the most, they end up being cornered by those whose voices are the loudest. The prices of petrol and diesel at the pump have not budged an inch since November of last year when they were revised downwards following a dip in the international price of crude. Since then, prices have risen sharply by more than 50% (offset to some extent by the appreciation in rupee) and our oil-sector PSUs (effectively the public exchequer at the final resting point) long habituated to operating on an undemanding cost-plus basis, are bleeding. Likewise, the massive subsidy on LPG or cooking gas for domestic use is another example of an outrageously distorted sense of priorities. India has many poor people who are deprived of the most basic necessities of life. Yet, our largest subsidies are on commodities that we know for certain are not consumed by the poor.

And then, by not raising the prices of petrol and cooking gas (or better still, giving a free hand to market forces to set the prices), it is not that nobody is paying for it. On the contrary, we pay for it everyday in the form of reduced services from the government and higher taxes in other areas. Very often, the payment is by way of a debt to be paid off by the succeeding generations. When a parent does that to his child, it is called being improvident. When the government does it, it suggests responsiveness to the needs of the people.

Even as subsidies distort and corrupt, we know from experience that in the real world we have to be practical. An occasional lie here or there, hurts no one and often makes life easier. And so it is with economics. A well-targeted subsidy here and there does not hurt. Indeed, it can even do a world of good, by keeping a lid on discontent and preventing things from boiling over. But what happens when it gets totally out of hand, as happened in the centrally planned economies of Eastern Europe and the USSR, where prices were determined by fiat and seldom had any equation with cost or with market forces like demand and supply. In other words, where everything is one lie after another leading to a series of unending lies.

Well, when that happens, what we have is a work of fiction belonging to an unlikely genre called economics. Unlike the literary version, this one invariably has a nasty ending.


Tuesday, October 16, 2007


(A radical new plan for attracting private sector investment into the education of the poorest and most deprived of our children to give them a way out of the vicious circle of poverty)

There is just no denying that despite India’s recent economic achievements, large parts of our population continue to see little improvement in their day-to-day lives. What is perhaps worse, they also have very little hope for a better future. A telling statistic is the continuing and widespread prevalence of malnutrition among children in India. At more than 40% (and greater than in sub-Saharan Africa), it is the surest indicator of the blighted future that lies in wait for so many of us.

The problem is not just that so much poverty exists, but that given current realities, it is likely to be handed down as a cruel legacy from poor parents to children who remain poor because they would lack the skills to pull themselves up. Either they do not go to schools or they are forced to drop out early on.

We know from experience – so much so it’s now an entrenched part of our collective wisdom – that there are limits to what the government can do. The Indian story, in common with many other countries, has been that government efforts have in-built elements of waste, inefficiency and graft that compel the use of disproportionate resources to achieve even modest goals. Therefore, attracting private sector investment into this whole area of educating and otherwise taking care of our most vulnerable children  those who have clearly slipped through the mesh of the existing, woefully inadequate schooling system  would be an ideal solution to strengthen and supplement government efforts. But having said as much, the problem is also equally clear. How do you draw their interest into ventures that offer no profits and therefore no motives other than charity? To some extent, it can be remedied by a well-structured series of tax incentives. But the prospect of losing out on current revenue when governments are generally strapped for cash, has strictly limited appeal.

Here then is a new idea. I propose that the private sector be invited to set up schools and educational institutions for the very poor and disadvantaged (or take them into existing quality schools and colleges) with the incentive that as when such children grow up and start earning their livelihood, the income tax paid by them to the government over their life-time would go to the entity that nurtured and educated them. The beneficiaries will be under no obligation whatsoever to their benefactors. Nor will they be required to do anything out of the way. Instead, using modern information technology, the system would essentially involve a centralised database that would automatically pick up the income tax collected from them and match it with their benefactors.

The basic idea – of enlisting the services of a more efficient private sector for an identified national cause, by offering them a share of the future gains that accrue from the venture – is actually not very new. Something like this has already been put into successful practice for building up our physical infrastructure, as in getting private entities to build roads by allowing them to collect and keep the toll for a defined period. Thanks to this, India’s highways have changed beyond recognition, all in the space of a few years. And now, I suggest it is time for this idea to be extended to our social infrastructure as well.

Of course, once it is required to be put into practice, a lot of detail and fine-tuning would be needed. Should it be the whole amount of the income tax paid or only a part? Should it be for the lifetime or for a pre-determined period? How do you ensure that only the genuinely poor benefit? What about kids who do so well out of it that they get jobs abroad and do not pay any tax here? Or how about someone who becomes a successful businessman and understates his earnings? And then, if there are different schools and colleges involved in a particular case, who gets what and how much?

I believe these are at best minor quibbles. After all, we live in an age where technology offers many easy solutions to problems of centralised data and record keeping. While there are procedural aspects to be sorted out by thought and debate, the important issue is to reconcile to the idea of private participants motivated not by altruism, but by future profits. Yes, this idea is about bringing in the element of windfall gains into the area of education for our poorest and most miserable. Much in the way that privately owned companies drill for oil and continue to drill even when some wells turn out to be dry, the private entities would have a powerful incentive to look after and take care of some of our most vulnerable children and their families and lead them out of the vicious circle of poverty. They would know that even if a small minority plucked from our poorest could be nurtured to join the ranks of our wealthy and successful, they would be looking at mega profits.

As for the beneficiaries, every child who emerges with some degree of success would have pulled up one family out of this vicious circle of poverty begetting more poverty. And as for the government, the only sacrifice is the loss of that future income tax revenue that anyways would not have accrued but for this idea. Besides, in a country like India where indirect taxes account for much of the tax revenue, it is not that by forgoing the income tax component, the government loses out on everything. On the contrary, it will continue to earn (and earn substantially more) from all his purchases and consumption that will continue to be taxed.

I believe it is a revolutionary idea. I also believe that it is a simple idea that can actually be implemented without too much of a hassle. I hope that this simplicity is not its undoing. After all, we are once again in a milieu where ideas to fight poverty are considered worthy and genuine only if it involves the government stepping in with ever more grandiose ‘poverty alleviation’ schemes involving hugely increased expenditure riding on the back of increased tax collection from the rich.

The idea of doing good to the poor has only so much appeal. The idea of being seen to be hurting the rich carries more cachet.

But that is another sad story.