The just enough budget

The budget has become something of an annual fiscal exam for spendthrift democracies around the world. In the age of globalisation, India finds itself in good company, that of the United States and a number of European nations, in trying to convince investors and creditors that it can skirt the fiscal cliff. Recent news in India has been alarming, with slowing growth, a high current account deficit and a persistent budget deficit. In this context, what can one expect from Finance Minister P. Chidambaram’s budget? What should one expect?

Instead of traditional electionyear goodies, we have been told to expect that the deficit will stay at 5.3 per cent of the GDP this year and decline to 4.8 per cent of the GDP next year. While the goal of deficit reduction is unassailable, both the timing and the likely means to this end are worrisome. Short-term cuts to capital investment such as infrastructure undermine future growth prospects, and are likely to exacerbate economic inertia. Higher tax rates are a reward for free riders: they amount to doubling down on those who already pay tax, while giving another free pass to those who manage to avoid it.

One barometer of the government’s appetite for cures over palliatives will be the introduction of the long-awaited goods and services tax (GST). The GST, favoured by economists as a means to rationalise the tax system, is the camel’s nose for removing tax-barriers to domestic trade. But it will require compromise and political courage by both the Centre and the states, and could easily be undone by the complex array of exclusions that have already been bandied about. Even if the budget manages to hit a few short-term targets, it looks less likely to address deeper reforms, which are essential for sustained growth.

The many-headed hydra of fiscal consolidation seems the most attainable of these reforms, both because it has become the focus of financial markets and ratings agencies, and because it is suitable for a piecemeal approach. The transition from in-kind to cash transfers to support the poor has already been discussed. Although cash can also be misappropriated or misallocated, it is a step towards transparency and takes the government out of the business of managing stocks and flows of basic commodities. While it is no panacea, if implemented correctly — with appropriate targeting and biometric identity verification — it is a step in the right direction.

But fuel and fertiliser subsidies are an almost equal part of the story. Even after previous partial deregulation, the prices of diesel and LPG remain heavily regulated, shifting slowly and belatedly in response to world prices. Distortions in the pricing and subsidies for urea, compared to phosphatic and potassic fertilisers, have led to under-budgeting and overuse of the former (see the Kelkar committee report). The final strand of fiscal consolidation is tax reform, with an emphasis on increasing efficiency in enforcing existing rules, rather than raising tax rates.

Labour market reforms always seem to fall below the fold, too, although there is no more fundamental an issue for Indian’s medium-run growth prospects. It is important to remember that India is fundamentally a labour-abundant economy. Agriculture accounts for more than 50 per cent of employment; the informal sector for more than 80 per cent of manufacturing employment; and notwithstanding the innovation and growth in the IT sector, most service sector workers are still employed in single-man, low-productivity operations. There is no hope for these unskilled workers to be more productive other than labour reforms that open up large-scale labour-intensive manufacturing. While no one would advocate low-cost manufacturing as the ultimate goal of development, it is an essential intermediate step, given the demographic and skills profile of our workforce.

The long-run goal, of course, is to have a highly trained and productive workforce and to sustain high rates of growth and improved standards of living. In order to achieve that goal, one needs to move beyond the easy comfort of recent successes in the service sector and recognise the need to reform the higher education system. Our current system, like that of many former colonies, was set up to produce an elite cadre of graduates to feed the colonial bureaucracy, which it continues to do well, with the difference that its graduates now staff top corporate jobs in India and around the world. But to catch the next wave of innovation and to unlock the demographic dividend of a young workforce, we will need to produce more and better graduates on a vast scale. With currently only a handful of top-200 (or even -300, -400, or -500) ranked universities, the system needs higher standards, investment, and more entry and competition.

At the same time, there is an acute shortage of well-trained medical professionals. Research in both rural and urban settings has shown that the poor receive a shockingly low quality of care. Particularly telling is the finding by Jishnu Das and Jeffrey Hammer of the World Bank that private practitioners tend to provide better treatment despite, on average, having lower qualifications than the staff at public health centres. Reform is an imperative, not a luxury.

Democracy and the market economy share common strengths and weaknesses. Unlocking a multiplicity of views and ideas is empowering both politically and economically. Yet, both systems, for different reasons, have the danger of producing leaders who are short-run optimisers, who know how to (or at least try to) win the next election or satisfy investors in their next earnings call. In the calculus of democratic politics, it’s a fair bet that the Union Budget for 2013-14 will be a one-year plan that tries to do as little harm as possible to the government’s chances for re-election and defers real reform to the future, and in fairness to the political process, it is unreasonable to expect otherwise. But in politics and economics, hope springs eternal.