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Friday, November 19, 2004

Most economists across the world generally agree that India can grow faster if only certain impediments to prosperity are removed. India’s growth at a reasonable 6-7% per annum, and being the world’s fourth largest economy in purchasing power parity terms testify Indian entrepreneurial energies and ambition of the ordinary citizens. True, China continues its scorching pace of growth, but there is every reason to believe that we have the potential to match China's growth in the coming years.

Yet, our growth potential, due to many political and social causes, remains unfulfilled. But let us focus on the resource crunch holding rural economy back, overcoming which can accelerate growth. The verdict of 2004 Lok Sabha election is primarily the result of the anguish of rural India and its desire to join the growth process.  Irrigation, watershed development, roads, power, productivity, value addition, storage, marketing and non-farm job creation – all are crying for urgent attention.  The National Water Commission estimates that about Rs.100,000 crores is required to complete the 444 on-going projects and create 21 million hectares of new irrigation potential. Similarly, 75.70 million hectares of degraded or drought-prone land needs investment in soil and water conservation measures.  Rural roads, improved power distribution, better application of post-harvesting technologies and modern marketing infrastructure ─ all need huge investments.

All these are state subjects, but states are strapped for resources. Their tax revenues are barely sufficient to pay wage bills. Pension burden is mounting, and within a decade, in most states pension payments are likely to exceed wages for current employees.  The selective, hasty and unconditional approval of the huge wage increases recommended by the Fifth Pay Commission in 1997 had devastating consequences on states’ finances.

Short-term populism and political compulsions in states, such as power subsidies and incapacity to raise taxes, have aggravated the situation. There are only three measures to raise resources without increasing deficits ─ wage reduction, de-subsidization, and raising taxes, fees and user-charges.  If all these steps become politically infeasible, we reach a dead end.  Low investment, poor infrastructure, inadequate human development, absence of value-addition, inability to create jobs, endemic poverty, rising strife and violence, political instability and economic stagnation – all these constitute a vicious cycle in which many states and regions are trapped.  What is happening in Bihar, Jharkhand, Eastern UP, Telangana and Rayalaseema of AP, Vidarbha, and several other pockets of India is not accidental.  And if we do not earnestly address the challenges of investments, economic growth, sensible governance, and rule of law in these regions, we would have proved the prophets of doom and advocates of undemocratic solutions right.

Happily, there are practical, democratic, acceptable, relatively painless ways of getting out of the vicious cycle of poverty, unrest and violence.  Let us examine three possible approaches to raising resources while reducing fiscal deficits: reducing subsidies; raising taxes, tariffs and user-charges; rescheduling debts and utilizing foreign exchange reserves; and properly directing union allocations.

Subsidy reduction is always a painful exercise even in totalitarian regimes. The food riots resulting from increased prices in Poland in the early 1980s eventually led to the rise of Solidarity under Lech Walesa, and sowed the seeds of collapse of the Soviet empire and communist regimes. Yet, unproductive subsidies absorb resources from more critical areas of investment, and retard growth. Food, fertilizer, and power subsidies together account for nearly Rs.75,000 crores in India today. In the name of food subsidies, the corruption and inefficiency of state agencies are rewarded. A substantial reduction of this subsidy and dismantling of the FCI and the regulatory regime will also release vast resources. Where necessary, price support for farmers can be provided by innovative mechanisms, and domestic price level can be maintained by judicious application of import tariffs, and liberal exports.  Similarly, fertilizer subsidies are a euphemism for freebies to inefficient industry.  Moreover, subsidy on urea is leading to excessive use of nitrogen, at the cost of productivity. Removal of urea subsidy, and allowing duty-free import of fertilizers will have the twin advantage of saving precious public money, and containing input prices.  Power subsidies are complex, and have been discussed earlier (Financial Express Oct 22, ’04). The trick here lies in metering of power, graded tariffs and well-targeted subsidies to discourage overuse of power and precious ground water, and decentralized management of distribution through franchises at sub-station level. The savings on account of de-subsidization must then be transferred to local governments for specific infrastructure investments. Once people see direct and alternative benefit at the local level de-subsidization becomes politically feasible.

Raising taxes is always difficult.  A primary reason for George Bush's re-election is his tax cuts.  All economists agree that our low tax, GDP ratio will not permit either sizeable investments or reduction of fiscal deficits. The only acceptable and relatively painless way of raising resources is taxation linked to specific services and projects, like the education cess imposed recently.  The more local the taxes are, the easier it is to establish such a link.  And the stronger the link, the more willing is the citizen to pay. In US, citizens who hate to pay federal income tax gladly shell out vast sums towards education tax in their local school districts.  Similar principle can be applied to healthcare.  Local taxes and user fees can be raised in a variety of areas provided the money goes directly to improve the services.  Such an approach has the added advantage of generating demand for better services. Such innovative resource mobilization involves empowerment of stakeholders and local governments, along with creation of institutions to enforce fiscal responsibility and accountability.  Politicians and bureaucrats should realize that empowering local governments strengthens – not weakens – state governments.

Finally, the union is planning to implement some form of employment guarantee scheme, and provide additional resources for education and healthcare, which does not guarantee outcomes. Employment guarantee funds should be linked substantially with soil and water conservation schemes. By definition, such watershed schemes help poorer and drier areas.  Allocations in social sector must be contingent upon restructuring and improvement of delivery systems. In many cities, the public expenditure in schools is of the order of Rs.15, 000 per child per annum, and is at par with fees charged by reputed private schools. Yet, the results are appalling because of poor delivery system, lack of innovation and accountability.

The union government needs to evolve a holistic approach to overcome fiscal and political constraints and leverage its strengths in raising resources and getting good value for the money spent to accelerate rural growth.


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