The Back-Benchers' Blog

Today morning, a friend of mine sent this link to me, asking for an opinion. In a nutshell, the honourable Supreme Court has directed the centre to provide subsidised foodgrain to BPL families in 172 poorest districts around the country. It is very hard to predict how successful the policy will be, but to me it sounds good. There is no doubt that this is only a redistributive policy and will not do much to alter the status of the impoverished as such.

In the arena of economic policy making, there’s that golden rule – You can’t make all the people happy. Given this binding constraint, it’s natural for the birds of the same feather to flock together. Any debates over any economic policy take the shape of Us vs Them, with “experts” belonging to various ideological stance taking potshots at each other. Redistributive policies are particularly problematic in this regard. Any proponent of them is termed as “Marxist”, “Socialist” and any opponent is called a “Ruthless Capitalist”.

At this moment, it would be a good idea to take a step back and think why redistributive policies exist and what they strive for. To do so, we must acknowledge the fact that many developing democracies are ridden with problems of crony capitalism (scams, corruptions, underhand dealings etc) due to the fact that politicians are not very accountable. People do not expect politicians to do much and politicians oblige without retribution. The weakest section of the society makes only marginal progress over the years and the development as a whole is highly inequitable. This is often termed as a bad equilibrium by economists.

 (An example of a bad equilibrium would be Indian football. Good players don’t take it up as a profession as there is not much money. So, a lot of talent is lost. Therefore, with the limited talent it’s hard to attract a lot of money. So there’s a less money. And it goes on.) To get out these bad equilibria, the economies need a big push, some kind of a shock that will induce a transition. Similarly, people are stuck in a bad equilibrium of poor education, income awareness and stunted overall growth leading to poverty, and the cycle goes on. It is really naive to suggest that democratic elections can solve this problem and that India has a strong electoral system where such grievances can be addressed. In this paper, Jessica Gottleib, a Political Science PhD candidate, has demonstrated (using Mali as a case) that democracies fail when voters are less likely to control politicians and that political elites are likely to collude. As she says, “I argue in this paper that democratic failure in developing countries is evidence of a bad equilibrium where voters expect little of politicians and governments perform poorly without retribution.”

This is so true in India’s case that it does not even merit a discussion. Therefore, we need some push for us to set on a path of transition to a good equilibrium. In a good equilibrium, people will consume more and be more educated. This cannot be achieved overnight. The concept behind subsidised food, NREGA, cash/kind transfers, free education is that with these subsidies the poor will tend to educate and provide better nutrition to their children and the society will eventually reap its benefits.

Any redistributive policy essentially means we tax the rich and transfer the revenue to the poor. Let us not get into the ethical foundations of redistribution for now. Let us only first see why it could be beneficial for the society to have such policies. Needless to say that it is common-sense economics but still many people seem to “forget” it. Typically in most countries, number of poor people significantly outnumbers the rich. So, let us consider a test economy that has one rich guy and four poor guys. The rich guy earns 100 rupees per day and the poor guys earn 10 rupees per day. The poor guys can only buy food worth 1000 calories with their 10 rupees and require 1500 to survive. The rich guy consumers 2000 a day (by spending 20 rupees) and spends some money on his luxuries. Now, if you take 10 rupees from the rich guy and distribute it to the poor equally then each person gets 2.5 rupees with which he buys food worth 250 calories. Given that the rich person’s income is now at 90 rupees it is very likely that he will still choose to spend 20 on food and cut down on his luxuries. That means that society’s calories consumption now is at 7000 calories starting from the initial 6000. Clearly, on this front there is an improvement. The only issue to be seen is how much worse-off the rich guy is by cutting down on his luxuries or savings. But it is very likely that the disutility caused to the rich guy by cutting on his luxuries will be significantly lesser than the gain in satisfaction that the poor people derive by starving a lot less.

Of course, the example above is very simplistic but this is the central concept that redistributive policies rest on. However, there are ethical considerations to this problem too. For example, how much of a proportion of income should or could the government take from the rich to be given to the poor? What is a ethically correct? It is extremely hard to answer these questions. There cannot be any magic number. But practically, the Government, no matter how populist it is, cannot really expropriate the rich beyond a point because extremely high tax rates are known to induce strong disincentives for working. The industrious and entrepreneurial people of the society are not likely to take up such activities when the tax rates are very high. Therefore, it is in Government’s interest to not harm these people beyond a certain extent as generation of wealth in a society rests critically on them.

And then, you have the king-of-all-nonsense-criticisms. Inflation! This is particularly popular amongst the “hey, I can talk about economic policy too” kind of people. Firstly, if you look at the above example it is conceivable that since the demand for food products will increase, we are likely to face inflation. But then, is it a bad thing from society’s perspective? In fact, this could even be taken as a success of the policy that overall consumption of the essential commodities is now higher. But more importantly, there is absolutely no empirical evidence to support this claim. Those suggesting that Consumer Price Index rose after NREGA came need to take a course in causality. A simple correlation does not establish any causation. In fact, as Paul Krugman shows, decline in overall grain production is most likely to be culprit. Overall, there is about a 5 percent decline in production. And an estimate of price-elasticities by the USDA shows that it takes about 25 percent rise in price for a 1 percent fall in consumption. Given that global consumption must fall by 5 percent, it warrants a 125% increase in food prices from the US estimates. Naturally, the estimates will vary according to country but it is enough to realize what a 5% decline in production can do to your prices.

However, there is one aspect where I am not very comfortable with redistributive policies. That is their impact on long-run. As shown in this paper by Das and Ghate, redistributive policies unambiguously reduce growth in the long-run. While it is true that growth is not the parameter on which the success of these policies should be measured, what it does establish is that you choose to not make your pie as large as it could have been otherwise. We need to see if the societies with better redistributive policies result in more egalitarian societies with better nutrition, education and overall well-being. While many developed nations do show these traits, it is the causality that is in consideration here. Whether high growth facilitates stronger redistributive policies and more egalitarian societies or more egalitarian societies achieve higher levels of overall well-being is an open question.

But, what is obvious is that the case for redistributive policies is absolutely not as weak as the pseudo-analysts want us to believe. There is, in fact, a strong case for those and we need to acknowledge that. But for the netizens active on twitter, facebook etc, the work of mainstream academic economists in Indian context is largely inaccessible unlike in the US where many great economists like Krugman, Mankiw, Beker blog regularly. I hope great Indian economists too drive the pseudo-economists out of the market and we have a healthy, constructive and fruitful debate on economic policy on public forums. That will pave way for policies that will build the future.