Saturday, June 27, 2015

Welfare schemes and the argument of Sociology vs Economics

India, like many emerging countries with poor being majority population, doles out many populist welfare schemes. Govt. subsidizes many services from education to healthcare to transportation so poor can afford and the burden on them reduces. It is not just the Central Govt. who regularly launches new schemes; State Govt.’s too do not fall behind in this race. One such scheme offered by State Govt. of Karnataka, distributing Rice at Rs.1 per kg, has become a hot topic of discussion. A noted writer in Karnataka opined that, Govt. should rather provide jobs to its people than subsidizing food grains. Few others hit back saying that those who oppose this scheme do not understand what poverty is and have not suffered the hunger like poor. While everyone agrees ‘teaching how to fish’ is better, supporters of the scheme ask how do you protect the poor from going hungry? They want ‘Sociology’ to be made a priority over ‘Economics’. So is the subject of ‘Sociology’ works against ‘Economics’?

Definitely not as both subjects are completely interwoven and influence each other heavily. Social progress always comes with economic prosperity. And you spoil the economy, there will be social unrest. In statistical terms, they are positively correlated. They do not work against each other. Then why do some people argue of Sociology vs Economics? It is their myopia. They only see immediate impact but fail to see (or rather not interested in) what lies ahead. Promoters of welfare schemes which appear extreme have some other agenda. Political parties who announce such schemes are more interested in shaping the opinions of public in the short term to win elections.

Let us see why many welfare schemes (which are extreme) do not achieve their intention though they seem to be working in the short term. For that we need to see how Govt. finances the subsidies. Govt.’s have incomes in the form of tax collection primarily but there are other incomes such as divestment, profits from the Govt. owned enterprises etc. There would be no problem if a Govt. balances its income with expenditure. Then there is no fiscal deficit. But with the new populist schemes they come up with, they would need additional funds that would demand raising taxes. Any populist Govt. would not raise taxes as it affects their image so they choose to borrow to spend on subsidies. You very well know borrowing and donating would make any super rich a beggar in no time. The same applies to Govt.’s too. For the borrowed money, Govt. will have to pay interest the next year. That would mean effective money available to spend in the next year’s budget will reduce. But Govt.’s will not reduce subsidies. So they will require more funds to be borrowed to keep the schemes going. When our leaders think politics is more about managing in the short term, they do not care about the increasing debt load. They simply roll it over, year after year. But a time will come to repay the debt and if Govt. finds it tough to get new loans, it will go bankrupt. This is what is happening in Greece. When Govt.’s default, disaster strikes their economy. Govt.’s assets will be put for sale at bargain prices but there will be no takers. There will be no more subsidies and unemployment starts bothering even those who work hard. All citizens end up paying the price for the subsidies they had availed. They cannot blame their Govt. as they only elected them to power. After all Govt. is representation of its citizens in a democracy. Now you tell me, do you still think you can achieve social progress by borrowing and funding subsidies?

Let us assume we Indians are sensible than Greeks (in fact we are). And the public debt remains at manageable levels. But yet these subsidies hurt everyone in the form of an invisible tax which haunts the poor more than the rich. It is termed ‘Inflation’. When any money is spent, it should produce the economical equivalent in the form labor, service or physical capital. If those subsidies do not pay back the Govt. in equal measure, it causes deficit. All wasteful expenditures of Govt. causes inflation. As Govt. goes on borrowing spree, it reduces the monetary liquidity in the banking system. When Govt. borrows the most money available in the money market or from banks, there will be less money available in banks to lend to private. Capital costs (interest rates) raise when the demand for capital increases. To ease the liquidity situation, central banks will have to run printing presses. When new money is created without equivalent economic value-add, it increases inflation. If Govt. borrows for foreign land, it affects Rupee that makes imports costlier and flaring up inflation again. Higher inflation coupled with higher capital costs ruins any economy, see how India fared during 2010-2014. Our GDP growth rates halved in that time frame and bad assets increased.

Higher inflation in the last five years has taken the prices up of all commodities, food grains and vegetables. Inflation had supply side problems too but monetary expansion (increasing money supply) had its role as well. Rice which was available at Rs.15-20 a kg five years ago went up to Rs.35-40 a kg by 2015. Now Govt.’s subsidizes rice. But inflation will not spare us. It will make other things expensive. You press a balloon on one side, air moves to the other side. Similarly subsidies funded with debt offer temporary relief but they do not solve the problem entirely. If our house rents go up, will Govt. subsidize it? Is not it better for market forces to take control than Govt. intervention?

Subsidies are for those who are extremely poor and aged who either don’t have means or ability to work. Definitely they are not for those who have affordability. If you have read this post till here, I expect that you would join with me in avoiding buying in subsidized market but rather pay the full price in the open market wherever possible, be it cooking gas cylinders or solar panels. And we would elect those who are sensible with subsidy spending. Poor need not just survive today. They need to live longer too.