An expensive face-lift?

When a gentleman living beyond his means proposes suddenly to spend a fortune to acquire a human face, those investing in his enterprise will be understandably nervous. No wonder the stock market crashed by 223 points on Friday, wiping out Rs 50,000 crore of wealth. It could fall further in coming months. A rather expensive face-lift, you might say.

Cynics see the Common Minimum Program of the coalition government as the usual bunch of political promises: motherhood, apple pie, sugar and spice for all credulous suckers. The government itself calls the CMP reform with a human face. But what about the cost? Face-lifts are expensive, and may not improve your looks much. The CMP proposes to increase education spending by 2% of GDP, and health spending by another 1-2% of GDP. It promises a National Employment Guarantee, debt relief to the states, and doubled agricultural lending, each of which could soak up another 1% of GDP. Each 1% of GDP is Rs 25,000 crore, so the bill adds up alarmingly fast.

How will it be paid? The CMP has no explanation, only a bland declaration that the governments revenue deficit will magically disappear by 2009. But much of the proposed new spending (on education, health, employment) is revenue expenditure. How then will the revenue deficit disappear? Through additional revenue maybe?

Problem is, all attempts to raise the tax/GDP ratio for a decade have failed. Revenue collection by the Centre and states remains stubbornly at just 14% of GDP. Marginal improvements seem possible, but little more. Meanwhile subsidies in the broadest sense (unrecovered costs of government services), are also 14% of GDP. If all your revenue disappears into subsidies, what is left for salaries, interest payments, or development? Another way of looking at government finances is that all revenue disappears in salaries, pensions and interest payments, so subsidies have to be financed by fresh borrowing every year.

Now, borrowings invested in new assets may yield enough returns to service your debt. But if you borrow just to give away subsidies, how will you ever repay your debt?

There are good and bad subsidies. We need merit subsidies which help the deserving, or have positive side-effects (eg. elementary education, primary health, rural infrastructure). We do not need non-merit subsidies which benefit those who can afford to pay (higher education, power, irrigation et al).

According to a NIPFP study, merit subsidies are barely 25% of the total. Rural education and health are in a mess because teachers and health workers absent themselves from work, with impunity. So much public spending is wasted. The Public Distribution system is so leaky that economist Kripa Shankar estimates that the government spends Rs 20 to get one rupee to the deserving poor. Rajiv Gandhi estimated that 85% of rural employment funds failed to reach the beneficiaries. Public spending of this sort represents not a human face but human waste. To use another analogy, it is like pouring water into a bucket full of holes, so too much leaks out.

The CMP promises to pour even more water into the same bucket, hoping to raise the level. It won’t happen. The real answer is to stop the leaks. One option is to make teachers, health workers and other government staff accountable to the people they serve and not distant state capitals. f rural parents are empowered to withhold the salary of an absentee teacher, that will do wonders for education.

This requires no rise in public spending at all, just empowerment of the rural poor. But that will antagonise the teachers unions so beloved by the Left Front, and so is ruled out as lacking a human face. Alternatively the poor can be given education vouchers and food stamps, which can be used to meet their needs from private schools and shops. That too will antagonise trade unions, and so is a no-no.

India already has a consolidated fiscal deficit of 10% of GDP, the second-highest in the world. This is overspending with a vengeance. The new CMP proposals will take the deficit to record-breaking heights, and maybe win us a medal at the coming Olympics in Greece . This is what worries investors.

Now, oldtimers will tell foreign investors that documents like the CMP are irrelevant fluff, that India will go on much as before. So, don’t panic, they will tell investors, the proposed human face will not turn out to be an expensive face-lift at all, it will just be an inexpensive mask. I am not sure foreign investors will be convinced, especially the new ones that do not know India well. Foreign investors have poured $ 10 billion into our stock markets since the beginning of 2003, stoking a boom. If some nervous ones now pull out a couple of billion dollars as a precaution, India Shining can quickly become India Collapsing.

What do you think?