Author: Dr V

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Power or electricity is very essential constituent of infrastructure affecting economic growth and welfare of the country. India is the 5th largest producer of electricity in the world. At an electricity-GDP elasticity ratio of 0.8 <for 1% increase in GDP, 0.8% increase in electricity generation required>, electricity will continue to remain a key input for India’s economic growth.

Uninterrupted, reliable power at reasonable cost is essential for the success of make in India which in turn is critical for the transformation of industrial sector which would provide jobs to burgeoning young population entering the labour force every month <1m new entrants to labour force every month>.

High tariffs and erratic supply for industry have led to a slow but steady decline in the growth of industrial electricity purchases from utilities and a gradual transition towards captive generation often using diesel gen sets which is more expensive as also more damaging to the environment.

Status of diesel gensets in India-

• 47% of firms report using a diesel generator
• Total capacity of the diesel generators (DG) in the country may be as high as 72 GW and growing at the rate of 5 GW per year
• DG capacity for industrial loads greater than 1 MW is 14 GW
• A substantial portion of the rest (58 GW) may be contributed by micro and small industries, with load capacities of less than 1 MW

Effect of captive power generation using diesel gen sets

• This particularly affects SMEs as they are unable to shift to captive power generation and when they do, they are unable to absorb the higher costs as their margins are generally very low.
•  Agro based and other industries are not able to develop in peri urban or rural areas and rural population either remain stuck in unremunerative agriculture or migrates to urban areas in search of jobs (distress migration)
• It affects competitiveness of our industry and our exports suffer
• Pollution, environmental degradation, climate change, global warming

What are the other issues in India’s power sector?

A- Complexity of tariff schedules

• There are separate tariffs for poultry farms, pisciculture, wetland farms (above and below a certain size), mushroom and rabbit farms, etc <complexity of tariff structure>
• It prevents economic actors from responding sufficiently to price signals due to the high cost of processing the price information <if it’s so complex, our mind can not take economically rational decisions>

Suggestion – Simplification of tariffs with, perhaps no more than 2-3 tariff categories <say low tariff below certain level of power consumption, high after that level and separate category for industrial tariff>

It will improve transparency and may well yield consumption and collection efficiency, along with governance benefits <consumers will be able to take rational decisions, no scope for rent seeking>

B- Tariffs And Cost-

Cmmon sense suggests avg tariff (AT) should not be less than avg cost of supply (ACS) but in India-

• Average tariffs in some cases are set below the average cost of supplying electricity
• Even after adjusting ACS for Aggregate Technical and Commercial (AT&C) losses AT continues to stay below the adjusted level of ACS in most states i.e tariff are set way below the required level <what are AT&C losses? Answer in comments>

Suggestion- -Tariffs reflecting costs are a necessary condition for discoms to sustain themselves over the long-run. So avg tariffs need to be raised while giving relief to poorer section of society. How?

Exploiting Progressivity to Lower Tariffs for the poor

• There is, at present, no specific policy guidelines on the intra-category cross subsidisation or subsidy provisioning
• The tariff schedule is progressive as the consumption increases, although, Avg billing rates (ABR) for all the consumption categories lies below the average cost of supply (ACS) implying that costs are not fully recovered even from high end consumers i.e state or industry subsidizing consumption of rich
• Other countries such as Bangladesh, Sri Lanka, South Korea, Vietnam and Brazil better exploit the progressivity of electricity tariffs in the domestic category <higher ratio of tariffs charged to the rich relative to poor>

Suggestion- make tariff schedule after welfare analysis and charge consumers progressively much more for higher consumption while simplifying tariff schedule

Advantage- cross-subsidisation occurs within the residential consumers itself< rich and consumers with high consumption intensity within the residential sectors subsidise prices for consumers with lower consumption>

Given their relatively inelastic price elasticity, rich consumers will continue to maintain their consumption even after price increase. The net effect is that the residential revenue collection becomes cost neutral for the discoms (loss making at present)

What has govt done so far?

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Open access policy and it’s present status

What is open access– simple- open to access electricity from any seller i.e. consumers being able to purchase directly from power producers rather than distribution companies.

Advantage- As it allows generators to sell power to the highest bidders while consumers can source their needs from the most economic seller, it promotes competition and efficiency

Open Access (OA) policy introduced under Electricity Act 2003, allows consumers with electricity load above 1 MW to procure electricity directly from electricity markets

OA provides an aggregation of the country-wide supply and demand on the same platform. Therefore, this constitutes a first step towards discovering a single market price for power around the country <if anyone can buy and sell from anybody freely it would ultimately create a single price for electricity and thus one market for power>

Barriers to open access-

Price barriers- cross subsidy surcharge– Industrial consumers procuring power from discoms subsidize residential consumers but they don’t have to do so if they procure power through open access, electricity regulator levies a surcharge to cover the cost of residential subsidy known as cross subsidy surcharge.

Idea was that cross-subsidy surcharge to be levied on OA consumers would come down over time. Nonetheless, cross-subsidy surcharges over the years have gone up as discoms lobby hard to increase surcharge.

Non price barriers- delay in granting open access, transmission constraints and congestion and transmission losses

In short price and non-price barriers come in the way of single-nationwide electricity prices through open access

Some achievements –

• highest ever increase in generation capacity <in 2014-15 the addition to plant capacity in utilities was 26.5 GW, much higher than the average annual addition of around 19 GW over last five years>
• bringing down the peak electricity deficit in the country to the lowest ever level of 2.4%
• Indian Railways (IR) attempting to shift to open access (OA) for power purchase
• From power deficit to power surplus <it’s possible because discoms are so much under debt that they just don’t want to purchase any more power, all the more important to expedite the shift to open access>
• Grid parity for solar generation is on its way to becoming a reality <tariffs reached an all-time low of R4.34/kWh in latest auction> <What’s grid parity? Why is it important? Answer in comments>/

Some policy decisions of govt of India-

A- Ujwal DISCOM Assurance Yojana (UDAY)  

• States shall take over 75 per cent of discom debt outstanding as of September 2015.
•  Reduction of Aggregate Technical & Commercial (AT&C) losses to 15 per cent by 2018-19.
•  Reduction in difference between average cost of supply and average revenue realized (ARR) by 2018-19.
•  Increased supply of domestic coal to substitute for imported coal.
• States shall take over future losses of discoms in a phased manner.
• Banks/FIs not to advance short term debt to discoms for financing losses.

B. Deen Dayal Upadhyaya Gram Jyoti Yojana (DDUGJY)

• Electrification of all villages <how many villages are unelectrified? what is criteris for calling a village electrified? Answer in comments. >
• Metering of unmetered connections for reducing losses.
• Separation of feeders to ensure sufficient electricity to agriculture and continuous supply to other categories.
• Improvement of sub-transmission and distribution network to improve the quality and reliability of supply.

C. Integrated Power Development Scheme (IPDS)

• Strengthening of sub-transmission and distribution network in urban areas.
• Metering of distribution transformers /feeders / consumers in urban areas.
• IT enablement of distribution sector and strengthening of distribution network.

D. Domestic Efficient Lighting Program (DELP)

77 crore LED bulbs to replace household and street light incandescent bulbs

E. National Tariff Policy, 2016

• Cross subsidy surcharge formula revised.
• Regulator will devise power supply trajectory to ensure 24X7 power supply for all consumers latest by 2021-22 or earlier

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Installed capacity in India as of 31st march 2016 (ratta laga lo)

• Thermal – 210 GW (185 Coal)
• Renewable – 85 GW ( 43 Hydro plus 42 others)
• Nuclear – 5780 MW
• Total – 301 GW

Break up of renewable energy

• Wind- 27 GW
• Solar- 6.7GW
• Biomass and bagasse cogeneration -4.8GW <what is cogeneration?>
• Small hydel- 4.3 GW
• Total- 43GW

Renewable energy target by 2022

• 100 GW solar power,
• 60 GW wind energy
• 10 GW small hydro power,
• 5 GW biomass-based power

The target for solar is split into 40 GW Rooftop and 60 GW through Large and Medium Scale Grid Connected Solar Power Project

Nuclear energy target

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Earlier the target was 63,000 Mwe by 2032 but now govt seems to have slashed it to just about 14,500 Mwe by 2024 as India-USA nuclear deal seems to be floundering (for more refer this link)

Electricity amendment bill 2014

• The Bill amends the Electricity Act, 2003.
• It seeks to segregate the distribution network business and the electricity supply business, and introduce multiple supply licensees in the market i.e separation of content and carriage<distribution network will now become like wires which anybody would be able to access just as we can obtain telecom services from any service provider, we would be able to get electricity from any provider>
• The Bill introduces a supply licensee who will supply electricity to consumers.
• The distribution licensee will maintain the distribution network <like present discoms> and enable the supply of electricity for the supply licensee.

For more info refer to PRS bill analysis here 

P.S.- This completes economic survey volume one in full retail with all the relevant concepts.

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India is midway through its demographic dividend <what is demographic dividend? Answer in comments>. To exploit this dividend India’s economy needs to do three things-

1. Movement of workers from agriculture to industry <pull factor of higher income in industry not push factor of distress in agriculture>
2. Shift of workers from informal to formal sector < good jobs– jobs that are safe and pay well, and encourage firms and workers to improve skills and productivity>
3. Rapid urbanization <it will automatically follow industrialization>

Note 1- there is lot of confusion b/w informal and unorganized sector. For the sake of simplicity, sectors not covered under factory act, 1948 (<10 workers with power, <20 without power) is unorganized sector. Informal sector is virtually synonymous with it.

Note 2- Formal jobs are jobs with some social security i.e insurance, pension, provident fund etc. Formal jobs would be there in organized or formal sector only but in formal sector, there can be informal jobs i.e contract workers not provided with social security.

Note 3-  NCEUS estimated in 2005 that out of total 470 million workers, there were 423 million informal workers in India of which 395 million belonged to the informal sector. The remaining 28 million were informal workers in the formal sector. <You can do the math of percentages>

For detailed information regarding, formal/ informal click here 

Let’s come back to main topic

Of the 10.5 million new manufacturing jobs created between 1989 and 2010, only 3.7 million (35%) were in the formal sector i.e. informal firms account for most employment growth, that’s why the need to promote entrepreneurship.

But informal sector jobs are much worse than formal sector jobs as-

1. Wages are, on average, more than 20 times higher in the formal sector.
2. Formal sector jobs also score better on some non-pecuniary grounds. For example, they allow workers to build employment history— which is important for gaining access to cheaper formal credit, getting better jobs in other enterprises.
3. Social security

Thus the challenge of creating “good jobs” in India could be seen as the challenge of creating more formal sector jobs, which also guarantees worker protection.

But why have formal sector jobs not increased? Also why has informalization < hiring of contract workers >increased even in formal sector jobs.

One of the reason is complex maze of labour laws which raise compliance costs as firms hire more workers forcing them to stay small. Needless to say, employers have started to get around them and one of the strategy is use of contract labour which is leading to informalisation of formal sector.  Also in the absence of reforms by parliament, states have taken upon themselves the task of reforming labour laws. You can read more abut need for reforming labour laws in this story, labour reforms in India

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Contract Labour

It provides two key benefits:

1. The firm essentially subcontracts the work of following regulations and managing inspectors to the contract labour firm
2. Because contract workers are the employees of the contractor and are not considered workmen in the firm, the firm stays small enough to be exempt from some labour law (<10 employees not under factory act, <100 employees not under industrial dispute act>

For these reasons, contract workers increased from 12% of all registered manufacturing workers (formal sector workers) in 1999 to over 25 per cent in 2010.

But this strategy is not without costs

1. Hiring workers through a contractor can be more expensive
2. Contract workers do not feel as much loyalty to the company as regular workers would, reducing employers’ incentive to invest in their training <low skilled workers, low productivity>
3. Worker protection and worker rights go down the drain

Hiring contract workers today hurts a firm’s productivity tomorrow, precisely because contract workers do not accumulate firm specific human capital.

Competitive federalism

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As labour comes under concurrent list <lists come under which schedule of constitution? What’s the procedure for amending the various lists? Answer in comments>, states have taken initiatives to reform labour laws. <But how can states enact laws repugnant to central laws? Answer in comments>

So Rajasthan govt has amended various labour laws <Quote these in mains answer or essay>

1. Industrial Disputes Act– government permission will not be required for retrenchment of up to 300 workers <only 100 workers in central act>
2. Trade Unions act- increased the percentage of workers needed for registration as a representative union from 15 per cent to 30 per cent<necessary as trade unions have become highly politicized>
3. Contract Labour Act -the amendments raise the applicability of the Act to companies with more than 50 workers from the current 20
4. Factories Act– currently applicable to premises with more than 10 workers with power and 20 without power, the amendments raise these numbers to 20 and 40, respectively

Good labour reforms should simultaneously increase social security and worker protection <unemployment allowance, reskilling of workers, pension, insurance etc> but Rajasthan govt has not any step in that direction in labour reforms.

There may be a possibility of competitive federalism becoming too competitive, inducing a race to the bottom with states pushed into giving too many concessions. But India seems far from such a situation. For example, changes that certain states are considering—such as Haryana’s proposed online filing of returns through a single form covering 12 separate labour laws and e-maintenance of all labour-related records—would likely improve compliance and worker welfare

Labour reforms help in entry of large firms <as compliance cost decreases, there is no incentive to remain small or any disincentive to hire more workers> and the benefits of the entry of a large manufacturing company to a state can go beyond scale, depending on the kind of products they manufacture. How ans Why-

1. What you export matters because exporting develops a country’s local know-how and supply chain networks, bringing it closer to the global frontier for the exported good <best product available in world market>
2. Skills may be more transferable across certain industries than others. For example, it may be easier to make cars—a complex product—once a country has developed expertise in making bicycles—a simpler but related product.
3. In this sense, what a country manufactures today matters not just because it affects employment and growth today, but also because it shapes the set of products a country can profitably produce tomorrow
4. For instance when China first entered the mobile phone assembly space, it was producing only electrical connectors and cables; now it is producing sophisticated, high growth and high valued-added products such as smartphones and tablets.

Lesson is that we should promote entry of manufactures which help develop know how which can be transferred across sectors to move to manufacturing high value addition goods with mobile phone manufacturing being a good example.

Relocation

Apart from the complex maze of labour regulations, there are some other factors which prevented development of labour intensive manufacturing in India

1. High cost of living in metros <it increases labour cost>
2. High transport and logistics costs and weak connectivity from suburbs to metro  <good connectivity and low cost transport would allow workers to commute to work to metros>
3. Low female labour force participation rate <suitable jobs not available near their homes>

For instance apparel industry is highly labour intensive, with 30% of costs from wages. Only 2-3% of costs are due to capital-intensive inputs like power. And yet India is ceding market share in the global apparel industry to countries like Bangladesh and Vietnam.

Formal sector apparel firms are about 15 times more productive than informal sector yet India’s apparel sector is dominated by informal firms while in China there are large apparel firms and now other countries are taking over.

To get around this some firms are now reloacting to smaller town and rural areas and it has several benefits for economy-

1. It spreads economic development to underdeveloped areas
2. Reduces spatial mismatch in the labour market <workers can work near their homes>
3. Improve competitiveness by raising firms’ access to lower cost labour <low cost of living in smaller towns>
4.  It improves female labour force participation, more earning, financial security for women, women empowerment but? How <very very important>

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• Most explanations of low labour force participation in India focus on supply side factors like cultural norms that frown on women working outside the home
• Less attention has been given to demand-side explanations, which essentially emphasise that a key determinant of female labour force participation (LFP) is the availability of suitable jobs <flexible jobs near their homes>
• It is a striking fact that the areas in India that have seen the greatest decline in female labour force participation in the last decade are those villages that have rapidly urbanised and are now part of towns and small cities.
• Farming jobs in these areas are no longer available, but women-friendly service sector jobs are yet to take their place

From this perspective, female LFP can be expected to depend on the availability of ‘suitable jobs’, which are flexible and located close to home located in small cities, utilizing women’s comparative advantage in garments, flexible working hours and childcare on site

Till know we say how firms are getting around the problem and how states are reforming labour laws but what should be the centre’s role?

It should be to ensure worker centric labour regulations by expanding workers’ choice and reducing mandatory taxes on formal sector employment.

Let’s understand this with the example of epf

What is EPF?

Employees provident fund is a scheme under which it’s mandatory for workers (organized private sector workers) earning less than 15k to deposit 12% of their income in EPF account. Employers contribute equivalent amount. EPFO invests it in mainly govt securities and they get annual interest rate based on return. They get principal plus interest at retirement thus it is meant to provide lump sum benefits to workers at the time of retirement.

Higher income individuals are not mandated to deposit any amount but they still do to take advantage of EEE provision. Read more about this provision and subsidy for rich in this economic survey chapter

Let’s analyse impact of EPF on workers-

1. From worker’s choice perspective, they are being forced to deposit significant proportion of salary in EPF (12% when they already earn so little)
2. They don’t get any tax advantage either (already outside tax bracket)
3. Various surveys have suggested workers would rather like cash in hand as majority of them are liquidity constrained
4. Further it’s difficult to access the account.

Though govt has taken some initiative to make it easier for them to access the account. For instance, uniform single account number portable across jobs and locations, e-filing and e-withdrawal etc, survey suggests giving workers the choice to get cash, remain in epf or move to NPS while keeping employers’ contribution intact.

Giving choice is important as EPF has high administrative costs. The EPFO requires that employers pay an administrative charge of 0.85% of the worker’s salary. This may not seem large, but it amounts to service charges of 3.54% (=0.85/24) which are higher than the rates of most private mutual funds. Competition will help bring down administrative cost.

Govt sought to reform EPF but buckled under pressure and rolled back all three reforms

Three EPF fliplops

1. Tax on withdraw- At present epf is EEE.  Proposal entailed taxing 60% of withdrawals and if that 60% is used to buy annuity it would be tax free i.e 40% of withdrawal tax free, tax on 60% if no annuity is bought

What is annuity-

It is a form of insurance or investment entitling the investor to a series of annual sums. Basically if you have 1000 rs and you buy annuity, pension fund manager will invest it in bonds and equities and you will get some amount every year based on your initial corpus and return on investment

Talking about annuity, why don’t you revise the hybrid annuity model of PPP project here

Objectives

• Idea was to make EPF equivalent to NPS which earlier was an EET scheme. Subsequently 40% was made tax free and remaining 60% would be tax free if used to buy annuity.
• Ultimate aim was to make India a pensioned society. As lump sum withdrawals are often used immediately, there’s nothing left for rest of the life. Learn about social security schemes in India here 

Protest– Of course salaried class wouldn’t like this idea. Government has no business deciding for them what they do with their money plus taxation is big no.

2. Restrictions on premature withdrawal -It was announced that workers will not be able to withdraw employer share till 58 years of age. At present, they can empty entire corpus if they remain unemployed for two months or at 54 years of age.

Objective– Idea was to prevent premature withdrawals so that something is left for the old age

Protest– It;s our money. you govt don’t tell us what to do. Further, often times we don’t have any job after 50 years of age. How would we survive for eight years without EPF money.

3. Reducing interest rate on EPF to 8.7% from 8.8%-

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Objective-

• Aligning them with market determined interest rates. If all interest rates are falling and return on govt securities also falling as inflation comes down, there’s no reason for epf interest rate to not fall
• As in future even inactive accounts will get interest benefits, future surplus would fall and future rates would come down drastically, so start cutting rates now <at present accounts which show no activity for three years don’t get any interest>

Protest- that EPFO had generated enough return to warrant high interest rates

What I don’t understand is how EPFO generate such a high rate of return when it invests almost entire corpus (95%) in govt securities and if everything is to be invested in govt securities, what’s the need of an organization called EPFO? <Ye mere man ki baat hai>

Before we end this chapter, let’s learn in brief about National Pension Scheme (NPS)

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• It is a pension scheme <defined contribution scheme i.e. employees contribute while they earn and get pension according to corpus accumulated during the working years> which is mandatory for govt workers (except armed forces) who joined the service after 1st july 2004. <Earlier there was defined benefit scheme in which pension amount was fixed based on years of service
• Employees deposit 10% of their salary which matching amount by govt.
• Even private sector workers can choose to invest in NPS voluntarily (unorganized sector workers not covered under EPF) <EPF is compulsory and only salaried employees under organized sector can invest in EPF>
• Minimum investment towards NPS is 6000 rs per year
• With NPS, people have the flexibility to choose between different asset classes to invest in — equity, corporate bonds and government securities <In EPF >90% investment in govt securities while NPS is allowed to invest up to 50% in equities>
• As people get to take some exposure with equity, they can earn higher returns over the long term <flip side is that there is no assured return in NPS while there is assured return on EPF>
• The Pension Fund Regulatory and Development Authority(PFRDA), an agency under the administrative control of the Finance Ministry is the regulator

Read about all the labour reforms of the present govt here

Before reading this chapter, it’s important that you read Chapter three – spreading JAM, chapter two – exit problem/ chakravyuha challenge and fundamentals of subsidy.

• Fertilizer accounts for large fiscal subsidies (0.73 lakh crore or 0.5 %of GDP), the second-highest after food.
• Only 17,500 crores or 35 per cent of total fertilizer subsides reaches small farmers

Where does the rest (65%) of subsidy amount go?

Obviously it leaks out to black market, large framers (bounty for the well off) and inefficient producers (exit problem).

We will come to the question of leakages later but before that let us know a few basics about fertilizer sector and it’s regulation in India.

1. There are 3 basic types of fertilizer used—Urea, Diammonium Phosphate (DAP), and Muriate of Potash (MOP) i.e N,P,K fertilizers.
2. Urea dominates the sector. It is the most produced (86%), the most consumed (74%) and the most imported (52%).
3. Urea also faces the most government intervention <50% under movement control compared to 20% for other two fertilizers,>
4. Urea also receives maximum subsidy (70% of total fertilizer subsidy) as well as in per unit terms (75% of cost of urea is subsidized compared to 35% for other two)
5. Urea is also not included in nutrient based subsidy regime

Nutrient based subsidy

Under this method, subsidy is given on the basis of nutrient content in the fertilizer. Suppose govt decided it would give 100 rs subsidy per kg of potash. Now, if cost of a fertilizer which contains 1 kg of potash is 1000 rs, govt will give 100 rs and he would be able to sell it at 900 rs. <govt does not fix retail price, govt gives same amount of per kg subsidy to all manufacturers, if production cost is less, you can sell it lower prices and capture market. It incentivises inefficiency this way.

Contrast this with urea subsidy which is cost plus based . In this regime govt fixes price of urea. Suppose govt fixed urea price at 500 rs per kg. Firm A produced 1 kg urea at 700, govt will give it 200 rs (700-500) so that it could sell it at 500. If more efficient firm B produced 1 kg of Urea at 600 rs, it will get 100 rs subsidy (600-500). Clearly, there’s no incentive to be efficient. More inefficient you are, more subsidy you get.

Other benefits of nutrient based subsidy

• Note that in cost plus method, govt can only subsidize a few fertilizers. But in NBS, govt has to simply state, it will give 100 rs per kg for N, K, P, Boron, Sulfur, Zinc etc. It will thus encourage production of complex fertilizers <many nutrient including micro nutrients in the one fertilizer>
• Complex and micro nutrients will increase the productivity of soil.
• It will encourage greater competition , leading to productivity gains.

Now let’s discuss 5 kind of govt intervention in urea sector

1. Controlled maximum retail price <encourages diversion and black marketing>
2. Firm specific cost plus subsidy <inefficient firms get larger subsidies>
3. Consignment specific subsidy to importers
4. Canalization of imports Only 3 agencies allowed to import <shortages when domestic production falls>
5. Movement control <govt tells how much to import and where to sell>

All these controls result in leakages. As we saw earlier only 35% of subsidy reaches small and marginal farmers.

1. Black marketing– Simply because the principle of one product one price (we discussed it w.r.t. LPG earlier) is violated.

Urea is only subsidized for agricultural uses but it is used for industrial purpose also < one of the ingredients in chemical industry, explosives, automobile systems, laboratories, medical uses, flavour enhancing additive in cigarettes and others>. As we know cost of subsidised urea is 75% lower than cost of non subsidised urea which gives strong incentive to divert it to the black market. Why?

• Simple- Suppose urea for agri use is 250 rs and for industrial use is 1000 rs, there’s strong incentive to sell it to industrial consumers at 750 rs and show it as urea for agri use.
• Similarly, urea is diverted to B’desh, Nepal where urea prices are high.

Result- Shortage of urea in domestic market.

Who suffers – small and marginal farmers. Rich farmers are well connected and get subsidies urea while small farmers have to buy urea from black market at much higher price <51% of farmers buy urea at above M.R.P.>

In the three eastern states bordering Bangladesh, 100 per cent of farmers had to buy urea at above MRP in the black market <diversion to B’desh>

Black market effects are aggravated by a further regulation—canalisation. As we saw , only three firms are allowed to import urea into India, and they are also instructed when to import, what quantities to import, and in which districts to sell their goods. And we all know how good govt is in forecasting needs.

Result- Shortages and shooting up of urea prices when demand is at it’s peak and invariably small farmers suffer disproportionately.

Reform by govt.-neem-coating urea

• Neem-coating makes it more difficult for black marketers to divert urea to industrial consumers.
• Neem-coating also benefits farmers by reducing nitrogen losses from the soil by providing greater nutrient to the crop <less urea required>
• Work as pesticide
• Less water pollution

2. Benefits large farmers– A regressive subsidy. As we saw small farmers suffer due to black marketing while large well connected farmers take advantage of subsidies.

3. Subsidy to inefficient firms– result of cost plus regime which does not encourage efficiency gains.

Result – even though urea consumption has increased steadily over the last 15 years, no new domestic production capacity has been added, leading to a large dependence on imports. Efficient firms are forced to shut their shops.

Externalities of urea prices

What is externality?

an externality is the cost or benefit that affects a party who did not choose to incur that cost or benefit <for instance, vehicle owners pollute the environment, we all suffer the consequences an example of negative externality. Can you give us an example of positive externality in comments plz>

• It’s clear urea is under priced compared to other fertilizers resulting in excessive usages.
• Ideal N:P:K ratio for Indian soil is 4:2:1 but actual ratio is 8.2:3.2:1 i.e excessive usage of urea

Result-

• Deterioration of soil quality
• Fertilizer leaching to water bodies resulting in pollution of water
• Algal bloom

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Reforms- aim of reform is to eliminate leakages while benefiting small farmers

1. decanalising urea imports—which would increase the number of importers and allow greater freedom in import decision–would allow fertiliser supply to respond flexibly and quickly to changes in demand
2. bringing urea under the Nutrient Based Subsidy program

Turning fertiliser into JAM

Fertilizer subsidy is an ideal case for JAMming (Chapter three) as leakages are high and central govt controls fund flows.

Also, urea manufacturing is not labour intensive so no harm to workers.

Ideally fertiliser subsidies would be targeted only at small and marginal farmers. But there are problems with targeting

1. Assessing poverty—based on landholdings or some other measure—will be difficult
2. How to target tenant farmers and sharecroppers <10% of all farmers are such farmers and they should not be excluded in any case>
3. Relatively low levels of last-mile financial inclusion in much of rural India <last mile challenge, chapter three>

What can be done if not JAM?

Set a cap on the number of subsidised bags each household can purchase <just like 12 subsidized LPG cylinders> and require biometric authentication at the point of sale (POS) <BAPU (chapter three)>

• Requiring biometric authentication would make it harder to conduct large-scale diversion
• Imposing a cap on the total number of subsidised bags each farmer can purchase would improve targeting <Small farmers would still be able to get all their urea at subsidised prices but large farmers may have to pay market prices for some of the urea they buy>

As urea is more sensitive, it could be initiated first for other fetilizers

Other reforms-

• Rationalise subsidies to domestic firms <shifting to NBS regime> which would release fiscal funds to spend more effectively on schemes that help poor farmers, such as drip irrigation and connectivity through the Pradhan Mantri Gram Sadak Yojana
• Secure long term fertiliser supplies from locations where energy prices are cheap
• Encourage Indian firms to locate plants in countries such as Iran following the example of the Fertiliser Ministry’s joint venture in Oman, which allowed India to import fertiliser at prices almost 50 per cent cheaper.

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Suggested reading- Fertilizers and challenges of reform

Self study- New Urea Policy 2015

Preferential Trade Agreements (PTAs) have been proliferating, especially since the establishment of WTO and about 619 PTAs have been signed so far of which 413 are already in force <there are only 185 sovereign states according to UN>.

But not all PTAs are same. Go no further before reading this blog to understand hierarchy of FTAS (cover pic) in detail – What is economic integration and what are the different types of trade agreements?

India and FTAs

• India has long-standing commitment to multilateralism under WTO agreements but in line with global trends, India has made use of FTAs as a key component of its trade and foreign policy. If WTO is going nowhere, we can’t just sit and expect WTO negotiation to conclude, we also have to sign FTA or we will be left behind
• So far, India has mainly focused on partnering with other Asian countries, and in goods more so than in services <with SL, Afghanistan, Thailand, Singapore, Bhutan, Nepal, Korea, Malaysia and Japan and regional trade agreements SAFTA and ASEAN>
• Outside Asia, We have signed FTAs with Chile and MERCOSUR <What is MERCOSUR, answer in comments>

But not all FTAs are same and depth of integration offered by different FTAs in different sectors are different. For instance, the India-Korea CEPA contains chapters on Origin Procedures, Telecommunication and Audio-Visual Co-production, but these are not included in the India-Japan CEPA. There are provisions in India-Japan CEPA not included in Indo-Korea CEPA <this all creates complications as number of FTAs increase and they all have different rules, regulations and procedures> <What are rules of origin? answer in the comments below>

Concept of spaghetti-bowl effect / Noodle bowl effect

Concept was propounded by world’s foremost trade economist Prof Jagdish Bhagwati is analogy between the tangling of spaghetti or noodle in a bowl with the tangling of different FTAs, He argues that so many FTAs with their differential tariff rates, rules, procedures muddy water so much that leads to discriminatory trade policy and results in often contradictory outcomes amongst bilateral and multilateral trade partners.

Let’s understand this with an example- Suppose rule of origin rule in TPP implies that Vietnam can only export textile which is made from Vietnami Yarn. Now Vietnam has an FTA with say B’desh or India and Yarn is covered under it. Indian yarn is cheaper yet Vietnam will not buy it because textile manufactured from it will not be covered under TPP. Multiply it across more than 400 FTAs and you can understand how complex it can get and more complex it gets, advantage developed and bigger countries.

Small countries don’t have resources to investigate whether US is actually following rules of origin for it’s exports. At much bigger level, it would look like this

 

It’s safe to say that developing countries like India should invest their energy in successful negotiation of WTO rounds as they can negotiate them better collectively, outcomes are not very complex thus beneficial to less resourceful. But as we can not wait for that to happen indefinitely we should also sign FTAs which would be beneficial to us.

Mega-Regionalism

Until recently FTAs were signed mainly bilaterally and regionally <india-Bhutan, ASEAN ka SAFTA, North America ka NAFTA, Europe ka EU> but of late PTAs have begun to morph into mega-regional agreements, which would encompass a large share of world GDP and trade. Consider for instance:

1. TPP- 40% of Global GDP and 33% of trade (already sgined)
2. TTIP- 50% of GDP and 30% of merchandise trade, 40% trade in services (negotiations continuing) <TTIP is trans atlantic trade and investment partnership b.w EU and USA>

India is not a member of either of these two grouping but is negotiating it’s own mega regional- RCEP (regional comprehensive economic partnership) which is not as ambitious in scope as the other two agreements.

With the signing of TPP and TPIP, India will have access to these markets at higher costs <member countries will get preferential treatment; resulting in some negative impact on Indian exports and thus our GDP growth. Different studies suggest negative impact on India’s GDP from -0.1% to -.2%.

TPP/ RECP is very, very important topic for prelims/ mains/ interview. For prelims, name of countries in TPP, in RCEP, in ASEAN, in all 3 grouping, in only 2 groupings etc is very important. Look at the figure below, it will help you remember the names well

Other way to remember the names is continent wise

• 4 ASEAN members- Malaysia, Singapore, Brunei ,Vietnam
• 7 RCEP members-  4 ASEAN above + Australia, New Zealand, Japan
• 5 American countries Canada, Mexico, United States, Chile, Peru (3 from North and central America + 2 from South America)
• Please note that China and Korea are not part of TPP

For detailed analysis on TPP for mains/ interview purpose, please read our blogs here- TPP decodified and RSTV summary, importance of TPP

To PTA or Not to PTA?

Over the years, India has signed many FTAs, have they benefited us? As number of FTAs and mega regional pacts are proliferating, should we sign more FTAs?

Any FTA will lead to increase in trade as tariff and non tariff barriers come down but if it leads to much higher imports than exports and thus negative trade balance, impact can be considered as negative.

Concept of trade creation v/s trade diversion

Another aspect of FTAS which like Spaghetti bowl effect is a criticism of FTAS wrt WTO- whether actually trade is being created or is it merely shifting to inefficient firms?

Trade creation -In WTO, a country reduces tariff for every other country in this world and because of this tariff decrease, outside firms can compete with domestic producers and trade increases leading to trade creation.

Trade diversion– occurs when tariff preferences offered under an FTA causes a shift of imports from firms in non FTA member countries to less efficient firms within the trade bloc, which now become competitive due to tariff reliefs.

Let’s understand this with an example-

Suppose country B is imports mangoes from country C and D, Until now, it imposed 20% tariff on both, thus major market share is captured by country D which is more efficient but  now, B and C sign an FTA and now mangoes from C are imported at zero tariff. Consider this

Country	cost of production	Tariff rate	Actual landed cost before FTA	Landed cost after FTA with C
C	110	20%	132	110
D	100	20%	120	120

Now C has become more competitive and trade will get diverted from D to C, that’s another side effect of FTAs.

Impact of FTAs on India’s trade

• The overall effect on trade of FTA is positive and statistically significant
• With ASEAN, trade has resulted in more imports than exports, this widening our trade deficit
• Impact of FTAs on different industry segments fall differently <it’s only to be expected>

Conclusion

• FTAs have increased trade with FTA countries more than would have happened otherwise.
• Increased trade has been more on the import than export side, most likely because India maintains relatively high tariffs and hence had larger tariff reductions than its FTA partners
• The trade increases have been much greater with the ASEAN than other FTA.

What should be India’s stance towards FTAs and mega regional trade agreements?

• Multilateral trade liberalisation remains the best way forward
• But the WTO process seems to have been overtaken by preferential trade agreements
• Against this background, India has a strategic choice to make: to play the same PTA game as everyone else or be excluded from this process

In the current context of slowing demand and excess capacity with threats of circumvention of trade rules, progress on FTAs, if pursued, must be combined with strengthening India’s ability to respond with WTO-consistent measures such as anti-dumping and conventional duties and safeguard measures.

• For understanding economy concepts, read through our collections on Economics Concepts Simplified

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What is Fiscal Capacity?

It’s simply ability to generate revenues. As majority of the revenue of governments around the world is through taxes (other from various fees/user charges/ dividends etc), Tax to GDP ratio is often taken as proxy for the fiscal capacity of a govt.

Survey argues that state capacity and taxes are crucial determinants of long run political and economic development. But Why?

Govt can only spend as much as it earns (plus some limited amount of borrowings). So fiscal capacity i.e tax to GDP ratio also determines it’s spending capacity.

Political development-If spending is about the entitlements of citizenship in a democracy, taxation is about the obligations of citizenship <rights and duties>. As more and more people come into the tax net via some form of direct taxation <in indirect taxation, people don’t feel like they are paying. Don’t we all generally think, only some 4% of India pays tax while every one who buys something pays some form of indirect tax>, they will more actively take part in nation building<their money is at stake>.

Economic development- Democracy is a contract between the state and its citizens. The state’s role is to create the conditions for prosperity for all by providing essential services <such as law and order, enforcing contracts, roads, transport, health, education etc, for instance without enforceable property rights markets can’t function> and protecting the less well-off via redistribution <subsidies etc, providing minimum standard of living and reducing inequality>

What is citizen’s role in this contract?

• The citizen’s part of the contract is to hold the state accountable when it fails to honour the contract <provide essential services and redistribute to reduce inequality>
• But a citizen’s stake in exercising accountability diminishes if he does not pay in a visible and direct way for the services the state commits to providing <esp essential services. He is not paying, what does he care if state does not provide>
• If a citizen does not pay he either becomes a free rider (using the service without paying) or exits (not using the service at all). Both reduce the accountability of the state.

For instance, not many taxpayers send their children to state run schools i.e exit from the service, thus reducing accountability which leads to further deterioration in the quality of schooling. They simply don’t have stakes in the system. That’s why some promote banning or reducing to the minimum the role of private sector in primary education. And it is for this reason that Allahbad High Court ordered public servants to compulsorily send their kids to Public school. Indian express link here <whether order was complied with or not, I have no idea, May be UP wale can help us>

Taxation is not just about financing public spending, it is the economic glue that binds citizens to the state in a necessary two way relationship.

Precocious Indian phenomenon of economic development lagging political development

In terms of democracy index, India is highly developed with periodic free and fair elections, a very noisy and vibrant democracy but in terms of economic development India lags far behind the OECD countries.

Difference in taxpaying <only 4% of voting age population paying direct tax> and voting <universal adult franchise with >60% voting> might explain the phenomenon in India of there being reasonably effective episodic accountability <regular elections with non performing govts being shown the door> as opposed to ongoing accountability <reflected in corruption, law and order problem>.

• For instance, there has not been a single famine in independent India <Amartya Sen’s famous theory that famine simply don’t occur in democracies as they can’t afford it. Govt will simply lose power after a famine> but malnutrition remains a major challenge <discussed in chapter 4, women and children>. <Reason is simple, malnutrition is not as dramatic as famine so doesn’t attract media attention and in India accountability is episodic not ongoing>.
• Or the Indian state can organize mega-events <commonwealth games, gigantic elections> but routine safety for women is not ensured.
• Or state responds effectively to floods and tsunamis but finds water and power metering more challenging <can not perform routine tasks which calls for ongoing accountability but performs heroically in dramatic events which remain in public memory and thus public enforces accountability at the time of election i.e periodic accountability>

So does India tax and spend less as liberals/ left leaning commentators (Amartya Sen and Dreaze argue)?

Learn these facts and analysis by heart and reproduce them in essay / general studies /interview.

• India taxes (16.6%) and spends (26.6%) less than OECD countries (34% and 43%) and less than its emerging market peers (21% and 31%)
• For it’s level of economic development (countries with similar per capita income), India does not  tax and spend less
• But controlling for both the level of economic and political development (democracy), India seems to tax less and spend less and this is most significant with respect to social expenditure (on health and education) 
• India spends on average about 3.4 percentage points less vis-à-vis comparable countries on health and education <that’s a huge amount, India spends about 3.3% of GDP on education and 1.3% on health i.e 4.6% total while comparable democracies at similar level of economic development spend 8% on health and education>

Democracies tax and spend more, in part because they face greater pressures to redistribute and India lags behind here.

India’s tax to GDP ratio has increased by about 10% over the past six decades from about 6% in 1950-51 to 16.6% in 2013-14 (very slow growth)

This analysis seems like indictment of the Indian development experience since India has been a democracy for nearly 70 years. But in most of the advanced democracies, the big increases in fiscal capacity have been in response to wars (world wars) or in response to extreme crises (Great Depression of the 1930s) which led to a sharp expansion of the welfare state and the need to finance it. Independent India has not experienced shocks of such large magnitudes that created pressures to enhance state capacity.

western democracies have also had a much longer period of political evolution <USA became republic in 1789 v.s Inda in 1950> allowing them to build state capacity <taxation and expenditure institutions>

Now that we have established India taxes and spends less compared to other democracies, should India start taxing and redistributing more?

• The history of Europe and the US suggests that typically, states first provide essential services (physical security, health, education, infrastructure, etc.) before they take on their redistribution role. Why?
• Because unless the middle class in society perceives that it derives some benefits from the state, it may be largely unwilling to finance redistribution
• In other words legitimacy to redistribute is earned through a demonstrated record of effectiveness in delivering essential services
• if the state’s role is predominantly redistribution, the middle class will seek to exit from the state, will avoid paying taxes and coccon themselves in walled communities <state’s redistribution role is perceived as illegitimate as they pay taxes but state can’t even provide them essential services such as infrastructure, law and order, decent primary education>

As we saw earlier, in India they already send their kids to private schools thus reducing the pressure on the state <ongoing accountabilty is absent, lower class i.e poor are unable to hold state accountable for they don’t even have enough time to invest in these matters>. They thus reduce accountability and legitimacy of state even further.

A state that prioritises or over-emphasises redistribution without providing basic public goods, risks unleashing this vicious spiral.

Point is that India should invest more in essential services, law and order, infrastructure, pollution, congestion, health, education to earn the legitimacy before taking on big re-distributive role.

Number of taxpayers in India (Too few or adequate)

In India roughly 5.5% of earning individuals or 4% of voting age population is in the tax net.

Controlling for level of economic development, India does not have too few taxpayers but again if we compare India with countries with similar level of income but those who are democracies (political development), India seems to have too few taxpayers. It should be 23% while India only has 4%.

Top personal income distribution (Inequality in India)

Inequality is generally measured by Gini coefficient (more on that in separate back 2 basics economics article some other day). Other measure is to compare income of top quintile (20%) with bottom quintile (20%). But of late, greater focus has been on income and wealth of top 1%, even more of top 0.1%.

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We can see from the figure below that increasingly there is greater concentration of income among top 1% and even more so among top 0.1%. In 2012 top 0.1% held 5.1% of national income up from 3.6% in 1998.

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Moving To A Better Equilibrium On Taxation And Spending

India has not fully translated its democratic vigour into commensurately strong fiscal capacity <As we saw India taxes and spends less among democracies>

Reform through inaction — Do not increase exemption threshold. As income rises, more people would automatically come into tax net.

Additional 1.65 crore people would have been in the tax system and tax-GDP would have increased by 0.32% by 2013 if govt had not raised exemption threshold from 1.50 lakh to 2 lakh.

But beyond this low hanging fruit of not increasing exemption limit, to increase fiscal capacity (tax more) state must also increase it’s legitimacy.

• Government’s spending priorities must include essential services that all citizens consume: public infrastructure, law and order, less pollution and congestion, etc.<so that middle class does not exit v/s redistribution>
• Reducing corruption must be a high priority not just because of its economic costs but also because it undermines legitimacy<if citizens think public resources i.e their hard earned money going for taxes is being wasted, they would try to avoid paying taxes>
• Subsidies to the well-off (1 lakh cr, disccused in chapter 6) need to be scaled back.
• Tax exemptions Raj which often amount to redistribution towards the richer private sector will also need to be phased out. <govt announced phasing down of exemption and reducing taxes but not much guidance from the budget>
• Reasonable taxation of the better-off, regardless of where they get their income from—industry, services, real estate, or agriculture–will also help build legitimacy<presently agri income is not taxed and we all know politicians show all their black income as income from agriculture and plantation>
• Property taxation needs to be developed. Property taxes are especially desirable because they are progressive <rich owns more property, will pay more>, buoyant and difficult to evade, since they are imposed on a non-mobile good, which can with today’s technologies, be relatively easily identified.

Higher property tax rates can be the foundation of local government’s finances, which can thereby provide local public goods and strengthen democratic accountability and more effective decentralization. It would also put sand in the wheels of property speculation. Smart cities require smart public finance and a sound property taxation regime is vital to India’s urban future.

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In the article on fiscal policy (click here to read) we discussed conceptual framework behind subsidies. A good subsidy will be on merit goods (for everyone) and should be well targeted (to poor). If the subsidy is not well targeted, it can result in inclusion error (well offs getting benefits) and exclusion error (poor not getting benefits). We also discussed govt should be most sensitive about exclusion errors as they affect poor directly <poor woman not getting kerosene won’t be able to light up her home>. In the JAM chapter of the economic survey, we read JAM trinity has the potential to weed out ghost beneficiaries and thus minimize inclusion error. In this chapter we shall discuss, subsidies which leak to relatively well off sections of society <above bottom 30% in income distribution>.

Performance of a subsidy programme can be judged on two criteria

1. Equity- i.e subsidizing those goods and services that account for a large share of expenditures of poorer households <for instance food account for >50% share of household budget of poor but very little share of rich, subsidisng food or not taxing it at all will be proportionately more beneficial for poor than rich>.> On the other hand subsidizing a good/ service such as airfares/ ATF (aviation turbine fuel) which is mostly consumed by rich will not benefit the poor and thus will not be equitable>
2. Effectiveness– depends on how well targeted the subsidy is .Suppose a good is consumed by poor such as kerosene but also used in other industries <adulterating diesel for instance>, not targeting well will result in leakage. Higher the amount used by non targeted goods, lesser the effectiveness of subsidy.

Based on these aspects, let’s discuss the bounties for the well off by the govt.

The government spends nearly 4.2% of GDP subsidising various commodities and services. this data is from last year’s economic survey. This considers all implicit as well as explicit subsidies at both central and state level such as subsidised passenger fares, subsidised electricity etc. This is not how subsidies are shown in the budget. As we discussed in the fiscal policy article, govt budgets about 10% of expenditure as subsidies i.e about 1.6% of GDP (only major explicit subsidies are considered there).

Case of small savings – These schemes were created to mobilise saving by encouraging “small earners” to save, and offered above market deposit rates in accessible locations like post offices.

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We discussed that one distortion of small savings rate where rate is decided by govt is incomplete transmission of monetary policy (click here to read more about monetary policy and transmission) by banks but the issue here is are these schemes even benefiting small savers i.e. poor.

First things first, these are not just small. There are three types of schemes-

1.  “actually small” schemes- Eg. postal deposits, schemes for the elderly and women <poor people deposit small amount>
2. “notso-small” schemes- Eg. Public Provident Fund (PPF) <generally tax payers deposit upto 1.5 lakh rs limit i.e not so small amount and tax payers are at the top 5% of income distribution in India i.e not at all poor, not even middle but rich>
3. “not-small-atall” schemes– Eg. tax-free bonds issued by Public sector Companies <generally rich people deposit on avg 6 lakh per person i.e not small and poor don’t have 6 lakh rs to deposit>

Moral of the story so far is that we should not grudge first type of small schemes (post office savings schemes) for they are for the really needed i.e equity principle holds true.

But the benefit these schemes confer are much beyond the difference b/w rates of interest. Actual benefit is because of tax concessions and here they become even more iniquitous <poor even middle income groups are so poor, they don’t pay income tax. Only top 5% of population pay income tax>

How are savings taxed

Savings can be taxed at three stages

1. Contribution stage <when you deposit the amount>
2. Interest accrual <interesting earnings>
3. Withdrawal stage<when you take out principal and interest>

Income tax is inherently biased against savings; it leads to double taxation in so far both the savings and the earnings are taxed <taxation of deposits as well as interest earnings>. So to eliminate this bias and promote savings, tax incentives are given. So savings may not be taxed at all in what is known as EEE (exempt exempt exempt) i.e exempt from taxes at all three stages of taxation. Or they can be taxed at deposit and earning stage (TTT). Or tax at the time of withdrawal only (EET) or making earnings tax free (TET)

Note that, TTT or TET does not mean you are tax both at the time of deposit and withdrawal. Same income won’t be taxed twice. Hence taxation at the time of contribution is deemed to be taxed at the time of withdrawal.

Let’s understand this with example

Scheme	Deposit	Initial Tax savings (30%)	Interest (10%)	Tax on interest (30%)	Tax at withdrawal	Real interest
TTT	100k	0	10k	30k	0	10k-3k =7k
TET	100k	0	10k	0	0	10k
EEE	100k	30k	10k	0	0	10k + 30k in tax savings
EET	100k	30K	10k	0	30k + 3k	7k

Clearly EEE scheme (provident fund) and TET (tax free bonds) give higher returns. Survey calculates that implicit subsidy is about 6% (R 12,000 crore) on Provident fund (not so small savings) and 3.7% on tax-free bonds (not at all small saving and investment by largely rich).

This is based on data that only 5.8% of population earns more than 2 lakh rupees to come under income tax net. Even more starkly, major benefit is reaped by those in 30% tax bracket (income more than 10 lakh) who are among top .5% of population. IN developed countries, greater proportion of population pay taxes and thus these schemes benefit middle class as well.

So how should savings be taxed?

Case for concessional tax treatment of savings -tax concession for savings # higher post-tax return for the investor # positive substitution effect in favour of savings rather than current consumption. <higher savings # higher investment # good for economy esp for a capital starved economy like India>

But problems with the way scheme is designed in India

• It also creates a disincentive for savings (income effect), since the higher returns now require lower savings to meet the lifetime savings target. <If a person needed to save 1lakh rupee for his old age, he now will have to invest less to save equivalent amount>
• Tax incentives for savings, as designed in India, do not encourage net savings (contribution plus accumulation minus withdrawals) since withdrawals are also exempt from tax <no incentive not to withdraw full amount at the maturity>
• Tax incentives for savings distort the interest structure and choice of saving instruments. They just divert funds to specified savings instruments.
• They also increase the interest rate at which households are willing to lend funds to banks (i.e., make deposits) , thereby adversely affecting investment.<depositors won’t lend to banks at lower rates hence banks unable to pass rate cuts to consumers>
• regressive as they provide relatively higher tax benefits to investors in the higher tax bracket; in fact, the real “small savers”, who are largely outside the tax net, do not enjoy any form of tax subsidy on their savings.

Overall, tax incentives for savings, more so as designed in India, are economically inefficient, inequitable and do not serve the intended purpose. Hence, there is a strong case for review of the design of the tax incentives for savings schemes.

Economic survey suggests EET method of taxation for following reasons-

1. savings (contribution) reduce cash flow # the ‘ability’ to pay # taxation would create hardship # disincentive to save.<if I save 100k, consumption decreases by equivalent amount and over that govt taxes me, why would I save>. Taxation at the point of withdrawal (principal or earnings) occurs when the ability to pay is greater and therefore, justified on principles of taxation <after all, now my income is actually increasing>
2. TEE # taxation at the point of contribution # no immediate incentive to save # exemption of withdrawals # encourages withdrawal. Under EET # full deduction at the point of contribution and accumulation # incentive for savings # taxation at the point of withdrawal # disincentive for withdrawal.
3. TEE # withdrawals are exempt irrespective of the amount # no incentive for consumption smoothening <will withdraw the whole amount in one go>, Under EET # More you withdraw # come under higher income tax bracket # withdraw in staggered manner # consumption smoothening
4. no uncertainty about the potential tax liability
5. extremely simple in terms of compliance and administration
6. most developed countries and many developing countries are implementing the EET method of taxation of savings

Other bounties

Case of Gold-Top 20% consumes 80% of gold yet gold is taxed at rate of <2% compared to standard tax rate of 26% (centre + states)

Railways– Reserved class is hardly used by poor (bottom 30%), yet upto 34% of reserved class fare is subsidized.

LPG-91 % of subsidies are accounted for by the better-off as their share of consumption of LPG is 91% compared to 9% for poor (bottom 30%)

Electricity– Better off are subisdized about 32% of electricity bill while poor about 49%. But since 84% of electricity consumption is by better off, acutual subsidy amount will be pretty high.

ATF- There’s no point subsidizing ATF or taxing it less than diesel for no poor travels by air. Yey ATF tax is 20% compared to 55% for diesel and industry still keep clamoring for lower taxes on ATF.

Kerosene– 50% of PDS kerosene is consumed by better off.plus adulteration etc

If we add it all total subsidy to well off comes out to be more than 1lakh crore i.e 16b$ (.8% of GDP).rupees and we haven’t yet added corporate tax exemptions. Contrast this with expenditure on health, a merit good, social responsibility of govt, just 1.3% of GDP.

Addressing these interventions and rectifying some egregious anomalies may be good not only from a fiscal and welfare perspective <more govt budget for actual needy i.e poor>, but also from a political economy welfare perspective, lending credibility to other market-oriented reforms. <govt is pro rich barbs whenever any market oriented reforms are undertaken> It is also an opportunity foregone to help the truly deserving.

Criticism of this analysis (personal views)

• Higher taxes on gold hurts the jewelers. But most importantly promote black marketing, black money generation and corruption <people will buy gold at cheaper rate in Thailand and smuggle to India>
• People earning 2 lakh rupees or 5 lakh rupees can not be termed super rich by any stretch of imagination.5 lakh per annum for a family of 5 turns out to be kust 1lakh per capita i.e 8k rupees per person per month. Problem is with super rich(top .1%, not even 1%) and high amount og agri income not being taxed(issue addressed in next chapter)
• Political economy argument-Just as govt reduced interest rate on provident funds, barbs of pro rich, pro-corporate started being labelled on govt. Fact is that voice of vociferous minority(salaried middle class, super rich according to survey) is much more than silent minority(poor) as we discussed in chapter on exit problem.

If you haven’t read first four chapters, read them here first,  Chapter two, Chapter three, chapter four

Despite the high economic growth during the last two decades, India has not been able to improve it’s maternal and child health indicators at the desired pace. We failed to achieve health goals related to Millennium Development Goals(MDGs) and our maternal and infant mortality remains unacceptably high.

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India is in the middle of a demographic dividend which is going to last till about 2035-2040 (25 more years or one more generation) and it’s imperative that we invest in human capital to reap the fruits of demographic dividend. This will raise our long run economic growth potential.<What is demographic dividend? How does it help raise long run growth potential? Answer in the comments below.>

In this context, economic survey argues that given fiscal constraint <we can only spend as much as we tax plus some borrowing, never behave like arm chair pundits asking to raise budgetary allocation for everything without raising any taxes or train fares or bus fares> and state’s limited capacity to deliver public services <we know how state i.e. govts mess up almost every sector they get into, just see the performance of public schools i.e. state should not take tasks beyond it’s capacity; first improve capacity and then take additional tasks; just passing RTE or establishing 5 more AIIMS or IITs is not enough>, state should invest in relatively low cost maternal and early life health and nutrition programmes.

What’s the rationale behind investing in mother and child?

Intrinsic reasons– it improves quality of life directly and expands possibilities for the individual <if someone is not born healthy, chances are he would be unhealthy in later life as well>

Narrow economic logic

1. Research has shown that countries with better maternal and infant health “at takeoff” grew faster over the subsequent 20 years. <takeoff stages is similar to takeoff of an airplane, slow growing economy suddenly starts to grow very fast. For instance, China post economic reforms in 1979>
2. Tomorrow’s worker is today’s child or foetus and  events which occur while a child is in the womb i.e inside pregnant mother or very young (<2 yrs) affect cognitive development and health status even in adulthood i.e. if today’s child is weak, chances are tomorrow’s worker would be less productive.

Why does health of new born affects outcome much beyond the childhood?

1. the most rapid period of physical and cognitive development in a person’s life occurs in the womb <rapid development phases are most susceptible to environmental insults>
2. Dynamic complementarities in human capital accumulation- it simply means one human capital for instance health would affect accumulation of other human capital for instance education and training/skill in a dynamic way and vice versa. For instance healthy mother # healthy baby # learns better <cognitive development better in the womb as mother is healthy> and stays on in school longer. Or consider # unhealthy mother # weak baby # learns less and stays in schools for shorter period # less skilled and competent 

• research has shown that low birth-weight children benefit less from early-life cognitive stimulus programs i.e. early we intervene the better i.e. investment in mother and fetus. very young children
• success of subsequent interventions—schooling and training—are influenced by early-life development
• programs targeting younger children also appear relatively cheap in comparison to investments made in older children. For instance, iodine supplementation is way more cheaper compared to improving teacher quality or re-designing institutions to raise school accountability <good for fiscally constrained govt.>, also requires less service delivery capacity from the state, for instance, improving teacher quality would require teacher training, monitoring that they actually show up and teach in schools <investing in mother and child good for capacity constrained govt.>

The Dismal State of (Child’s) Play in India

Height is a good proxy for early life conditions and height is determined by early life environment and net nutrition.

“net nutrition” is defined as the sum total of (i) the nutrition available from the mother in the womb and during breastfeeding, (ii) the quantity and quality of the food that complements breast milk from 6-24 months, and (iii) energy losses due to disease and infection, and poor absorption of nutrients. <part 3 is an important cause of malnutrition in India due to open defecation and subsequent infections resulting in reduced absorption and increased losses in feces as well as due to high metabolism during infections>

Quick statistics

1. 48% of under 5 children are stunted (low height) compared to 39% in Sub Saharan Africa
2. 43% are underweight compared to 20% in Sub Saharan Africa
3. 28% are born low birth weight compared to 13% in Sub Saharan Africa

This data is taken from Amartya Sen’s book An Uncertain Glory which took data from UNICEF(2012). This condition of poor nutrition indicators comapred to much poorer and war torn Sub Saharan Africa is known as South Asian Enigma or The Indian Paradox and the low status of women is cited as one of the explanation.

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3 quick points about height for age in India

1. there has been improvement over time in both urban and rural India
2. there is a persistent rural-urban height gap which has not closed over the past decade
3. despite the progress made, India remains a negative outlier—our children are on avg shorter than healthy children

Consequences-height-cognitive development gradient

Greater the height, greater the cognitive development (of course corrected for genetic potential for height not that because Chinese are short they are less smart then tall Caribbeans)

• taller Indian children are considerably better readers than shorter ones (height proxy for nutrition which affects cognitive development)
• absolute reading ability has not increased over time i.e we have not made much progress in addressing the nutrition and education challenge

Clearly much more needs to be done to improve the nutrition situation in India.

The Dismal State of Maternal Health

As we have already discussed first 1000 days of life (nine month in womb plus 2 years) are most critical for a child’s development. They depend critically on maternal health (esp 9 months in the womb)

70% of infant mortality (children who die before reaching their 1st birthday) is due to neonatal mortality(dying before 1 month). A leading cause of this is low birth weight which is clearly due to poor maternal health and nutrition.

Consider this data-

1. 42.2% of Indian women are underweight at the beginning of pregnancy
2. 50% of pregnant ladies are anemic(low hemoglobin in blood) <data from An Uncertain Glory>
3. Women from richer households in India start pregnancy heavier,suggesting that resources are at least part of the reason for low pre-pregnancy weight <poor #less to spend on nutritious food #low pre pregnancy weight>

No surprises then that women in India gain only about 7 kgs during pregnancy, substantially less than the 12.5- 18 kg gain that the WHO recommends for underweight women.

Very very important sociological insights

Use these observations in paper 1 (society) and essay. They will certainly add value to your answers.

1. reason for poor maternal health is that social norms accord young women low status in joint households. <When compared across the same ages, till about age 35, fraction of underweight women exceeds that of men by at least 5 percentage points. > within-household nutritional differentials are stark
2. lower status of younger daughter-inlaws in families. <children of younger brothers in joint family households are significantly more likely to be born underweight than children of their older brother> Chacha’s children more likely to be born low birth weight than Tau’s<Tijori ki Key Badi bahu ke haath mein>
3. Indian firstborn sons are found to have a height advantage over African firstborn sons, and the height disadvantage appears first in second-born children, increasing for subsequent births<preference for healthy male heir>

Improving Maternal Health in India

Clearly much more needs to be done to improve maternal health.

Govt response-. The National Food Security Act of 2013 legislated a universal cash entitlement for pregnant women of at least 6,000 rupees.

But it will only be successful if families convert these payments into more, higher-quality food and more rest for pregnant women and to make sure it happens, the cash transfer could be paired with education about how much weight a woman should gain during pregnancy and why weight gain during pregnancy is important. <cash transfer plus health education>

You can follow the whole women empowerment story, click here

Universal v/s conditional cash transfers

Should cash transfer be universal i.e given to every pregnant women regardless of what she does with that money or conditional on women performing certain tasks such as visit hospital regularly, getting delivered in hospital, vaccinating her child etc as in Indira Gandhi Matritva Sahiyog Yojana (IGMSY)?

Conditional cash transfer seems better but it entails high administrative costs, delays and often lead to significant exclusion. Hence survey suggests the cash transfer should be given in a single, lump-sum payment early in pregnancy to avoid delays, reduce administrative costs, and ensure that it is possible for the household to spend the money on better food during pregnancy.

Case for going universal and problems with conditional cash transfer

With careful design and significant investment of state capacity, maternal health could be significantly improved during pregnancy.

The problem of open defecation

Facts-open defecation in India is much more common than in even much poorer countries <61% in rural India v/s 37 % Nepal, 32% rural Sub Saharan Africa, just 1.8% B’Desh>

Only lack of toilets or income constraints is not the reason, but there are sociological reasons

Fact- many people in rural India who live in households that contain working latrines that are in use by other household members nevertheless defecate in the open.

Research suggests that rural Indian households reject the types of latrines promoted by the WHO and the Indian government partly because their pits needed to be emptied every few years and empty the latrine pit is associated with the strong notion of purity and pollution <history of untouchability- work of disposing of human faeces is associated with severe forms of social exclusion and oppression>

Consequences- disease, diarrhoea, environmental enteropathy (reduced absorption of food) resulting in less amount of net nutrition available to kids as we discussed above.

Building toilets and ensuring people defecate in the open is an example of public good as even those who don’t defecate in the open get sick due to germs from people who defecate in the open.

Addressing open defecation

Govt. response- swatch Bharat Abhiyan

• In the last year alone, the government built over 80 lakh toilets
• UN’s Sustainable Development Goals commit to ending open defecation worldwide by 2030

Historically, open defecation in India has declined by about 1 % per year  <about 50 years before India becomes open defecation free>. We need to more than triple the rate of reduction to achieve SDG. For that, it is important to understand barriers to toilet adoption in rural India and promote latrine use <as we just learnt, it;s much of a sociological, behavioral problem>

Influencing social norms to make investment yield better return

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A big challenge is deeply entrenched norms and facilitating behavioural change. One can build clinics in villages or transfer money to pregnant mothers or build latrines, but how does one bring out the right usage of all this physical capital ?

Govt has a progressive role to play in changing norms, and thus the importance of high pitch campaigns such as Swatch Bharat Abhiyans.

The government has recognised the importance of influencing social norms in a wide variety of sectors—

• persuading the rich to give up subsidies they do not need (give up lpg subsidy campaign)
• reducing social prejudices against girls (selfie with daughter)
• educating people about the health externalities of defecating in the open (swatch bharat)
• and encouraging citizens to keep public spaces clean (swatch Bharat)

Way forward-

• Invest more resources in understanding the behavioral patterns and how to change them
• Create a Nudge unit within government for behavior change communication as other countries have done
  

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You might want to read- Blog from CD published on The Better India

7 Rights Every Pregnant Woman in India Should Know About (govt schemes for pregnant women in short, imp for exam)

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Open all the hyperlinks. Learn, understand and revise

Ask all your doubts in the comment section below or in doubts clearing forum . All your suggestions, criticism and feedback are most welcome.

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If you like what you read, show your support to Civilsdaily and give us a hi 5 at the Android Play – Click here.

If you haven’t read first three chapters, read them here first,  Chapter two, Chapter three

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India lives in villages and agriculture is the soul of Indian economy- Mahatma Gandhi

“Most of the world’s poor people earn their living from agriculture, so if we knew the economics of agriculture, we would know much of the economics of being poor.”- Theodore Schultz, Nobel laureate

As per NSS data avg annual income of the median farmer net of production costs from cultivation is less than Rs 20,000 (avg per cpaita income at current prices is about 98000 per annum in India)

Post independence agricultural success

• Chronic food shortages of 1960s (recall PL 480 programme) have given way to  grain self-sufficiency (not nutrition self sufficiency) despite a two-and-a-half fold increase in population.
• In 1966-67, Indian wheat and milk production were just about 1/3 of US output.  Contrast it with recent figures with wheat output being 60% higher than America’s, while milk output being 50% higher. (Result of green and white revolution)

This seems like a remarkable success. Then, what’s the problem with Indian agriculture?

• Indian agriculture has become cereal-centric (wheat and rice production to the neglect of pulses and oil seed production even though demand for protein based items is rising)
• It is regionally biased (Punjab, Haryana, western UP cornering all agri subsidies) and input-intensive, consuming generous amounts of land, water, and fertiliser
• Input intensive cultivation means there is sharp decline in cultivable land available per capita as also much lower levels of water per capita
• Challenge of climate change – erratic monsoon, more frequent flood and droughts
• Challenge of income- As we mentioned above avg income of farmer from agriculture is just 20000 per annum.

Let’s discuss some major issues with agriculture

1. Productivity/ Yield-  low productivity esp. in pulses is the central challenge facing Indian agriculture.

Consider the case of wheat and rice-

As already stated, Indian agriculture has become cereal centric and input intensive and these two crops are grown on most fertile tracts with irrigation facilities and corner bulk of agri support available to all crops across country. Yet, if we compare average yield of wheat and rice in India with China, we find that

1. avg yields of wheat is 39% below China and in case of rice 46% below that of China’s.
2. In wheat save for Punjab and Haryana, most states have yield lower than that of B’desh
3. In paddy even Punjab trails behind yield level of China while other states trail behind even B’desh.

Now if we compare productivity in pulses of which India is topmost producer, consumer as well as importer, yield gaps are even more stark.

1. On an avg, countries like Brazil, Nigeria, and Myanmar have higher yields
2. even the key pulse producing state of M.P. has 60% yield of China’s

Take home message from above analysis-

• Yield gap varies among states in India and we could make rapid gains in productivity through convergence within India
• For instance, in pulses, if all states were to attain even Bihar’s level of productivity, pulses production would increase by an estimated 41% on aggregate and we would be self sufficient in pulses

Why is pulses productivity so low (land related reasons)

• Most of the land dedicated to growing pulses in each state is unirrigated
• National output of pulses comes predominantly from un-irrigated land

Issue of Intensive use of water (problem of Indian agriculture becoming highly input intensive)

• Although water is one of India’s most scarce natural resources, We use 2 to 4 times more water to produce a unit of major food crop than does China and Brazil.
• We have invested in flood irrigation method (canal and tube wells) which is highly inefficient way of using water
• Also despite being water scarce, we are virtually exporting water by exporting water guzzling crops such as paddy, sugarcane, cotton also meat (not exactly crop)
• India now exports about 1 per cent of total available water every year (demand of 13m people)

Reason for inefficient use of water-subsidies on power and water for agriculture.

Result– water tables are declining at a rate of 0.3 meters per year

Solution-  shift to sprinkler and drip irrigation and rainwater harvesting.

• Leverage MGNREGA labour to build rainwater harvesting structures.
• accord “infrastructure lending” status to these new technologies (infra lending status decreases cost of borrowing to invest in these technologies)

Govt. response– Convergence of various schemes under PM krishi Sinchai Yojana which will help in convergence of investments in irrigation, from water source to distribution and end-use i.e. at individual farm level.

What is drip irrigation?

• A type of micro irrigation method in which perforated pipes are placed either above or slightly below ground and drip water on the roots and stems of plants, directing water more precisely to crops that need it
• It reduces consumption of fertiliser (through fertigation ) and water lost to evaporation, and higher yields than traditional flood irrigation <Fertigation is the process of introducing fertiliser directly into the crop’s irrigation system.>

Problem in adoption of drip irrigation- high initial cost of purchase and the skill required for maintenance.

Solution- the increase in yields and reduction in costs of power and fertiliser use can help farmers recover the fixed cost quickly. Hence, provision for credit to farmers to adopt this technology.

But there are teething troubles in agri finance as mentioned in last year’s economic survey box-

Problem of agri finance-

1. 40% of agri finance still by informal sector
2. 26% by usurious moneylenders
3. Share of long-term finance i.e. capital loans in overall credit going down over the years (70% in 1991 to 40% in 2011)
4. Share of small loans decreasing (less than 2lakh rupee loan from 78% of total in 2000 to 48 % in 2011 and 10 lakh and above from 8% in 2000 to 28%in 2011) March rush (jan to march quarter) in loan disbursal i.e. loan in lean season to comply with PSL
5. More and more agri loans going to urban and metropolitan areas

Implication of all this is that lending to agriculture is grossly misallocated # largely to ;arge farmers # not being used for capital formation # worst of all may not even be going into agriculture.

Issue of Minimum support Price (MSP) and Procurement being cereal centric and regionally biased

• while the government announces MSP for 23 crops, effective MSP-linked procurement occurs mainly for wheat, rice and cotton and indirectly for sugarcane via sugar mills
• Even in these crops majority of procurement is from Punjab, Haryana, Western UP.
• Poor farmers aof Rajasthan and Jharkhand are not even aware of any such MSP policy

Result– Regional disparity, excess stock of wheat and pulses and import and volatility in prices of pulses.

Solution-reorienting agriculture price policies, such that MSPs are matched by public procurement efforts towards crops that better reflect the country’s natural resource scarcities i.e. provide higher MSP for those crops which we import such as pulses and oil seeds and at the same time procure thise crops so that MSP policy is effective on the ground.

One way we discussed in chapter two was to not only taking economic but social and environmental costs and benefit into account while deciding MSP. Copy pasting from chapter two

• Eg. Costs of producing cereals in Punjab and Haryana; declining water table, soil quality degradation, post harvest burning of stalks causing pollution, rich farmers getting benefits
• v/s benefits from pulses; nitrogen fixation, lower import dependency etc.

For cereals a system of Price Deficiency payment can be instituted

Under this system if the price in an APMC mandi fell below the MSP then the farmer would be entitled to a maximum of, say, 50% of the difference between the MSP and the market price. This subsidy could be paid to the farmer via Direct Benefits Transfer (DBT)

For eg. If say MSP for wheat is 100 rs per kg. In present scenario, govt would procure it at 100 no matter if market demand is very low and prices some 10 rs per kg. Farmer has no incentive to switch to other crops to reflect market demand.

But in price deficiency payment, he will receive only 10 + (1/2*100-10) = 10 + 45 = 55 rs. It protects farmers while signalling him to produce crops reflecting market demand.

Issue of Agri Research and extension 

Agricultural extension is the application of scientific research and new knowledge to agricultural practices through farmer education. Basically educating farmers about the latest technologies being developed in the labs i.e. lab to land linkage.

While Indian Council of Agricultural Research (ICAR) with agriculture research universities played a key role in the Green revolution. Of late agriculture research has been plagued by severe under investment and neglect.

Three key weaknesses

1. Agri education is weak in states due to (i) resource crunch, (ii) difficulty in attracting talented faculty, (iii) limited linkages and collaborations with international counterparts, (iv) weakening of the lab-to-land connect; and, (v) lack of innovation
2. Low investment in public agricultural research in India. As share of agriculture GDP, it is even less than that of Bangladesh and Indonesia
3. Majority (63.5 per cent) of scientists have low to very low level of productivity

Solution

• There is need of instituting performance indicators in universities.
• Improve investment as a proportion of agri GDP
• securing participation from the private sector
• instituting a system in which the winner is offered a proportionately large enough award for innovating desirable agricultural traits (such as improving pules productivity considerably) but the intellectual property rights of the innovation are transferred to the government
• Leverage mobile phones to provide timely information to farmers
• Leverage the potential of drones (UAVs) to provide crucial information on crop health, irrigation problems, soil variation and even pest and fungal infestations that are not apparent at eye level to farmers
• Improve regulatory process to address concerns against GM crops while adapting high yielding technologies

Agriculture market segmentation

Last year’s economic survey mentions, effectively, India has not one, not 29 but thousands of agricultural markets.

Why are so many markets bad?

Whole capitalistic economy is dependent on trade, competition and specialisation and so many markets prevent that thus reduces overall welfare because it prevents gains through competition, efficient resource allocation, specialization in sub sectors (everyone has to produce everything as they can’t trade with others resulting in jack of all trades master of none) and fewer intermediaries. 

• If there were one common market, prices would be same from Kashmir to Kanyakumari and Dwarka to Puri (don’t add transport and storage cost please).
• In USA which has a common market, maximum price variation is in case of peanuts with highest prices being 1.75 times that of lowest prices. Remarkably it is lower than India’s minimum price variation crop Tur dal.
• It creates particular problem for perishables such as fruits, vegetables, onions, hence sudden and sharp spike in prices in one area while being sold at throwaway prices in some other area

Solution-

• Pass GST bill
• Create common national agriculture market
• Create better physical infrastructure
• Improved price dissemination campaign
• Remove laws that force farmers to sell to local monopolies i.e APMC act

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What you have to read for yourself

1. All the figures which are basically curves
2. Open all the hyperlinks. Learn, understand and revise
3. Read chapter eight A National Market for Agricultural Commodities- Some Issues and the Way Forward  from last year’s economic survey to understand concepts behind need for common agri market

Ask all your doubts in the comment section below or in doubts clearing forum . All your suggestions, criticism and feedback are most welcome.

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If you like what you read, show your support to Civilsdaily and give us a hi 5 at the Android Play – Click here.

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If you haven’t read chapter one, read that here first

We follow the standard pattern delineated in chapter one i.e. ‘quotable quotes’, statistics, major themes and recommended reading. Click on the hyperlinks in green to read and revise the topic hyperlinked.

Let’s get started

• A market economy requires unrestricted entry of new firms, new ideas, and new technologies so that the forces of competition can guide capital and labour resources to their most productive and dynamic uses
• But it also requires exit so that resources are forced or enticed away from inefficient and unsustainable uses
• Joseph Schumpeter expounded the concept of “creative destruction,” the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating new ones”

Structural impediments to India’s progress-

Problems of entry i.e. “licence-quota-permit Raj”

It has been largely taken care of by-

• liberalization(delicensing, end of permit quota system) , privatization (Divestment and end of public sector monopoly), Globalization (FDI and reduced tariff) reforms of 1991
• New initiative of across the board FDI liberalization and Start up-Stand up programme aim to further liberalize the entry.

But exit (chakrvyuah) remains the major challenge-

What is this problem of exit and what’s it’s magnitude?

• Inefficient and unsustainable firms are not allowed to wind down their operations and exit from the market
• In a normal economy, old firms would be the ones that were efficient, only then could they survive for that long and hence should be much bigger in size than new firms
• But in India avg 40 year old firm is just 1.5 times larger than a new firm (8 times in US
• Worst part is that a decade back they were 2.5 times larger i.e. inefficient firms are not allowed to exit and they remain small

What are the costs of impeded exit?

#1. Fiscal cost

• Of course, inefficient firms are supported by explicit (bailouts) or implicit (free power, reduced tariff, interest subvention etc) government subsidies
• High subsidies # high borrowings # high fiscal deficit # high debt # high interest cost.
• Add to this the tax revenue forgone, if efficient firms were allowed to take their place i.e. Double whammy of low tax and high subsidies

#2. Economic cost-

• Market economy is supposed to allocate resources/ factors of production (capital and labour) in the most efficient way towards most profitable ventures
• Lack of exit leads to misallocation of resources with enormous costs for a capital starved country such as India
• Overhang of stressed assets on corporate and bank balance sheets reflect same problem (remember twin balance sheet challenges, 4Rs solution discussed in part one) of  difficulty of apportioning costs of past mistakes

#3. Political costs

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1. Benefits of impeded exit follows to rich (firms are owned by richie rich naa) # govt charged as pro rich # No political constituency for reform measures (recall debate on land ordinance)
2. No action against willful defaulters # erosion of legitimacy of regulatory institutions such as RBI

Let’s take an example of fertilizer subsidies

• Fiscal cost- .8% of GDP, much of which leaks abroad or to non-agricultural uses, or goes to inefficient producers, or to firms given the exclusive privilege to import.
• But precisely for these reasons it has proved politically impossible to close the inefficient firms or eliminate the canalisation of imports. Rich farmers have internalised the benefits and prevent reforms

What causes an exit problem?

3 Is

#1. Interests – Power of vested interests which is aggravated by certain imbalances or asymmetry

• Concentrated producer interests (a few losers stand to lose by lot) v/s diffused consumer interests (individual benefit small but aggregate benefit large)
• Concentrated interests have more voice, backed by financial power and often democratic political systems tend to give disproportional influence to them (vocal minority v/s silent majority)
• In the case of administrative schemes, vested interests often create a market of their own, planning their actions to benefit from it: put differently, this is a case of supply creating its own demand
• Bureaucratic inertia perpetuates persistence
• 50 percent of schemes are 25 years old. extra vigilance is necessary to ensure that schemes remain relevant and useful over time. And vigilance should probably increase in proportion to the longevity. (for these reasons only concept of ZERO based budgeting was introduced)

Q. List down advantages/ disadvantages of zero based budgeting.

#2. Institutions– Paradoxical situation of both weak and strong institutions delaying exit

Weak institutions –

• Inability to punish willful defaulters (legitimacy of institutions itself is questioned)
• Judiciary- Tareekh pe Tareekh (time and cost overrun)

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• Eg. Debt recovery tribunal- share of settled cases is small and declining (4 lakh crore locked up)

Strong institutions so called referee or vigilance institutions– CBI, CVC, CAG, Judiciary combined with the asymmetric incentives for bureaucrats that favours abundant caution and hence the status quo.

Incentives are stacked against decisions to precipitate exit for fear of being seen as favouring corporate interests and hence susceptible to scrutiny, encouraging ever-greening of loans, postponing exit

#3. Ideas/ ideology

• Very difficult to phase out entitlements especially in a country with sizable poverty and inequality and one that is a democracy
• The objective is often laudable but once the policies and programs have been set in place, they are very difficult to reverse
• For instance, minimum support prices (MSPs) were envisioned as an insurance mechanism for farmers, but have become price floors instead, favouring some crops in some regions at the expense of other

How to address the problem

#1. Avoid exit through liberal entry: promote competition via private sector entry rather than change ownership through privatization. Eg. BSNL, MTNL were not privatized but liberal entry to private telcos

Advantage- It bypasses opposition from managers as well as labour interests.

#2. Direct policy action- Frame better laws, align incentives with the objectives

Govt response– a new bankruptcy law (solves weak institution problem), amendment to prevention of corruption act (solves strong referee institution problem), reforms in PPP (Kelkar Committee Report)

#3. Technology and the JAM solution:  Direct Benefit Transfer (DBT) for targeting and protecting the poor while removing distortions

• Brings down human discretion and the layers of intermediaries
• Breaks the old shackles and old ways of doing business

#4. Transparency: Transparently reflect economic as well as social, environmental and health costs and benefits

• Eg. Costs of producing cereals in Punjab and Haryana; declining water table, soil quality degradation, post harvest burning of stalks causing pollution, rich farmers getting benefits
• v/s benefits from pulses; nitrogen fixation, lower import dependency etc.

#5. Exit as an opportunity- It’s not the business of govt to be in business. For eg. loss making Air India

• Opposition from existing managers or employees’ interests;  solution- earmark resources earned from privatization for compensation and retraining;
• credibly ensure that reservation policies will be maintained in the privatized enterprise as well
• convert part of land into land bank and develop industrial clusters or in dense urban areas nurture start ups

A few more points about strong referee institution problems

1. Prevention of corruption act (PCA) definition of corruption does not include words like ‘corruptly’ or ‘wrongfully’ i.e. no requirement of mens rea or guilty intent hence even a benefit conferred inadvertently is sufficient to be prosecuted
2. For example, suppose an honest public servant makes, in good faith, an error of judgment and undervalues an asset which is being disinvested. Obviously that undervaluation causes a pecuniary gain to the buyer of the asset and is not in public interest, he is in way benefited but can still be prosecuted.
3. Misaligned incentive structure– external monitoring in the public sector tends to be skewed towards bad decisions that were taken rather than good decisions that were not taken (i.e. opportunities that were missed).
4. This promotes a culture where avoidance of mistakes is more important than the pursuit of opportunities

Result –

1. The reluctance of government to accept responsibility for its own delays in projects
2. The penchant for departments to appeal even fair and reasonable arbitration awards or lower court judgments
3. The tendency to raise tax disputes based on audit objections even if the tax authority disagrees with the auditor
4. The reluctance of civil servants to sell land or divest public enterprises

Solution:

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1. Amendment to prevention of Corruption act (prs bill summary) to prevent prosecution for mere administrative errors,  differentiating cases of graft from those of genuine errors of decision-making 
2. Providing investigative agencies with tools, skills and training to do a proper investigation of modern day financial crime and corruption so that culprits do not go scot free either
3. Reexamine the cost of elaborate but largely ineffective and counterproductive vigilance machinery

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What you have to read for yourself

1. All the boxes from the chapter plus bankruptcy box from statistical appendix
2. Open all the hyperlinks. Learn, understand and revise.

Ask all your doubts in the comment section below or in doubts clearing forum . all your suggestions, criticism and feedback are most welcome.

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If you like what you read, show your support to Civilsdaily and give us a hi 5 at the Android Play – Click here.

 

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Having discussed how to read Economic Survey earlier, we now start our series on economic survey chapter by chapter. We shall follow a standard pattern across all chapters. We shall begin by highlighting ‘quotable quotes’ or observations which might not otherwise come for discussion but nevertheless very important for general understanding, general studies papers and essay. We shall then present some very basic statistics from the chapter and move to discuss broad themes of the chapter. In the end, important reading from the chapter shall be recommended.

I have hyperlinked text with articles previously covered. So go back in time and read the articles if any doubt. Take this opportunity to revise the economy section of syllabus.

So let’s get started

1. It’s futile to expect “Big Bang” reforms because of two reasons

• dispersed nature of power in India, too many veto centers
• the absence of that impelling driver—crisis

Note that reform of 1991 was in response to major crisis, SEBI was given statutory backing in response to major scam in stock market and recent merger of Forward Market Commission (FMC) with SEBI was also a response to major scam.

Therefore, “persistent, creative and encompassing incrementalism” will be the key.

2. Being pro industry and pro market or pro competition is not one and the same

• India has moved away from being reflexively anti-markets and uncritically pro-state to being pro-entrepreneurship and skeptical about the state
• But being pro industry must evolve into being genuinely pro competition, and the legacy of the pervasive exemptions Raj and corporate subsidies highlights why favoring business (and not markets) can actually impede competition
• Similarly, skepticism about the state must translate into making it leaner, without delegitimizing its essential roles and indeed by strengthening it in important areas

3. Amid the world economy which is full of turbulence and volatility, India is a refuge of stability and an outpost of opportunity

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1. Survey projects GDP growth of 7-7.75% for the financial year (FY) 17
2. For FY16, GDP growth is estimated to be 7.6%
3. Forex reseves have risen to >350b$

Let’s now discuss some broad issues

India becoming more and more intertwined with global growth

• the correlation between India’s growth rate and that of the world has risen sharply to .42 from .2 for the period 1991- 2002 i.e. 1 % decrease in the world growth rate # 0.42 % decrease in Indian growth rates
• India’s exports of manufactured goods and services now constitute about 18 percent of GDP, up from about 11 percent a decade ago

Realizing long term potential growth of 8-10% requires a push on at least three fronts-

1. Creating genuinely pro competitive market by allowing inefficient firms to exit (Chakravyuha challenge) – Govt response- new bankruptcy code, rehabilitation of stalled projects, Kelkar Committee guidelines on PPP renegotiation
2. major investments in people— health and education- to exploit India’s demographic dividend.
3. Don’t neglect agriculture as 42% of Indian households derive the bulk of their income from farming. Smaller farmers and landless laborers especially are highly vulnerable to productivity, weather, and market shocks changes that affect their incomes. Govt response – PM Fasal Bima Yojana

Evolution of relative role of centre and states in the delivery of services-

1. With increased devolution of resources (courtesy 14th Finance commission), states need to expand their capacity and improve the efficiency of service delivery.
2. shift the focus from outlays to outcomes, and to learn by monitoring, innovating, and even erring.
3. the Centre should focus on improving policies, strengthening regulatory institutions, and facilitating cooperative and competitive federalism
4. while the states mobilize around implementing programs and schemes to ensure better service delivery

How does competitive federalism help?

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States that perform well are increasingly becoming “models and magnets.”

• Successful experiments in one state are models for others states to emulate by showing what can be done and stripping away excuses for inaction and under-performance.
• They are also magnets because they attract resources, talent and technology away from the lagging states, forcing change via channel of exit.

Twin Balance Sheet Challenge

What are twin balance sheets – Bank balance sheet and corporate balance sheet

Basically both are interlinked, as asset on bank balance sheet is liability on corporate balance sheet and if corporate does not repay debt, asset turns bad (Non Performing Asset or NPA) and both balance sheets get stretched. It results in banks not lending and corporate not investing resulting in vicious circle.

Solution-

What has been done so far– Indradhanush scheme, Strategic Debt Restructuring (SDR) scheme, 5:25 scheme

What needs to be done– 4Rs

1. Recognition-  Banks must value their assets as far as possible close to true value i.e. recognize NPAs as NPAs
2. Recapitalization–  capital position must be safeguarded via infusions of equity
3. Resolution– the underlying stressed assets in the corporate sector must be sold or rehabilitated
4. Reform–  future incentives for the private sector and corporates must be set right to avoid a repetition of the problem

But where would resources for recapitalization would come from given that government is committed to the path of fiscal consolidation?

1. Divest govt. equities in non financial companies and invest in PSBs
2. Dilute RBI’s capital to capitalize banks
3. govt can dilute its equity in banks to raise resources from the market

What should be the stance of fiscal consolidation?

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Learn Various types of Budget Deficits here- Budget Deficits Explained

Govt announced revised FRBM timeline last year with fiscal deficit target of 3.9% for FY16 and 3.5% for FY17. In this context question arises whether or not we remain committed to the same path of fiscal consolidation.

Arguments for accelerated fiscal consolidation –

1. debt ratio of the consolidated government (Centre plus states), 67 per cent of GDP is high compared to some countries in Emerging Asia
2. would reinforce govt’s credibility
3. also why such a commitment should be abandoned when the economy is growing at more than 7 per cent
4. Higher deficits may increase short term interest rates and thus hurt corporate investment and increase govt spending on interest

Arguments against-

1. 7th Pay commission award will increase expenditure by about .5% of GDP, to maintain same fiscal deficit, govt might need to slash capital expenditure
2. Public investment may need to be increased further to address a pressing backlog of infrastructure needs
3. current global environment is fraught with risks and India should not take chances against growth

In this context it is important that government utilizes resources available to it to increase capital expenditure in roads, railways, ports etc which increases overall productivity and competitiveness of economy.

Update- Government chose prudence and stuck to fiscal deficit target of 3.5% of GDP in the budget announced today.

India and WTO

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Two issues in agriculture-

1. Special safeguard mechanism (SSM) which came for discussion in Nairobi ministerial meeting . The question which arises is whether India even needs such protection

• We are already allowed tariff  from 40 per cent to 100 per cent (India’s modal rate in agriculture) to 150 per cent.
• In a preponderance of tariff lines, there is a considerable gap between applied tariffs and the level of tariff binding
• India’s only real need for SSM arises in relation to a small fraction of its tariff lines—some milk and dairy products, some fruits, and raw hides—where its tariff bindings are in the range of about 10-40 percent, uncomfortably close to India’s current tariffs, limiting India’s options in the event of import surges

India should call for a discussion of SSMs not as a generic issue of principle but as a pragmatic negotiating objective covering a small part of agricultural tariffs.

2. Food security/ stockholding issue

• The particular policies (MSP) which are being defended are those that India intends to move out of in any case because of their well-documented impacts:
• decline in water tables, over-use of electricity and fertilizers (causing health harm), and rising environmental pollution, owing to post-harvest burning of husks
• the government is steadfastly committed to providing direct income support to farmers and crop insurance which will not be restricted by WTO rules

The way forward in WTO on agriculture

India should consider offering reduction in its very high tariff bindings and instead seek more freedom to provide higher levels of domestic support: this would be especially true for pulses going forward where higher minimum support prices may be necessary to incentivize pulses production

India’s “big-but-poor” dilemma

• India’s self-perception as a poor country translates into a reluctance to recognize and practice reciprocity (give-and-take) in trade negotiations
• India’s policies have a significant impact on global markets and it has become a large economy in which partner countries have a legitimate stake in seeking market access

Net effect- India is unable to play reciprocal game in trade negotiations and WTO is fast becoming irrelevant (not good for India)

Cost of reluctant engagement-

• India is excluded from Trans Pacific Partnership (TPP) and it is shaped in a way that do not take into account India’s important interests (the rules on intellectual property)
• If and when India joins, it will be not on India’s terms but on terms already cast in stone, terms that India could not influence because of being perceived as not engaged fully

What should be India’s response-

We should use our growing markets as leverage to attain our own market interests abroad, including the mobility of labor and engage in reciprocal game to strengthen WTO.

How should trade policy deal with ongoing stress?

Chinese dumping, weak global environment, protectionist measures abroad, beggar thy neighbor policies etc .

Broad principle- resist calls to seek recourse in protectionist measures, especially in relation to items that could undermine the competitiveness of downstream firms and industries. For instance– imposing higher duty on imported steel hurts domestic manufacturers such as cycle manufacturers and lead to inverted duty structure.

Three sets of responses-

1. Exchange rate. Keep rupee’s value fair, avoid strengthening using some combination of monetary relaxation, allow gradual declines in the rupee if capital flows are weak, intervention in foreign exchange markets if inflows are robust.
2. India should strengthen procedures that allow WTO-consistent and hence legitimate actions against dumping (anti-dumping), subsidization (countervailing duties), and surges in imports (safeguard measures) to be taken expeditiously and effectively.
3. India should eliminate all the policies that currently provide negative protection for Indian manufacturing and favor foreign manufacturing. Implement GST asap.

What you have to read for yourself-

1. All the boxes- read especially Box 1.5: El Niño, La Niña and Forecast for FY 2017 Agriculture
2. Open all the hyperlinks. Learn, understand and revise.

Ask all your doubts in the comment section below or in doubts clearing forum . all your suggestions, criticism and feedback is most welcome.

Suggested Reading

1. Economic Survey For IAS | Chapter 02
2. Economic Survey For IAS | Chapter 03
3. Economic Survey For IAS | Chapter 04

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Having already discussed how to best read volume one of economic survey,  I shall now discuss, what to focus on and what to leave in the volume two of this amazing document.

Those who haven’t read part one, don’t move ahead without reading part one – How to read the Economic Survey

At the very outset let me tell you that volume two is not that interesting and is full of facts and figures and not much of analysis. Hence only selective reading is recommended.

There are nine chapters in volume two which basically cover happenings in the economy during last one year with some forward guidance. Chapters are pretty longish with most of them crossing 20 pages (only 9-13 pages in volume one).

Chapter one gives broad overview of the economy and glimpses of what to expect from the subsequent chapters. After that there are chapters on fiscal policy, monetary policy, external sector, agriculture, economy and services, climate change and human development. As I have already mentioned, there’s not much of analysis and most of the chapters make for very boring reading and not much important for examination.

There’s only one chapter which I would recommend you to read line to line, for every word is a virtual gold mine and that chapter is chapter eight, climate change and sustainable development. Please note down important points and try to understand the analysis of double counting of aid as climate finance, why CDM market is down and various issues associated with green finance.

What else to study?

1. As mentioned in the part one, boxes are important. But in this volume many boxes are rubbish. I am highlighting not to be missed boxes, rest you can skim through. Box 1.1, 2,3, 3.2, 3.3, 3.4, 3.5, 4.1(very imp), 4.2, 4.3 (very very imp), 5.1, 5.2, 6.1, 6.2 (very imp), 6.4 (imp), 6.5, 6.6, 7.1 (read), 7.2 (only first part related to medical tourism), 9.2.9.3
2.  Following selected portions are recommended for line to line reading

• Pathways to productivity in agriculture in chapter five from 5.26 to 5.61,
• Tourism including medical tourism in chapter seven from 7.25 to 7.29
• Issue of women employment, unpaid work and care economy in chapter nine from 9.5 to 9.23
• Draft bankruptcy code on page no. A 4 of statistical appendix

What else is important in volume two?

Authentic data about GDP growth, share of agriculture, industry and services in GDP and employment, savings, investment, gross fixed capital formation, major export and import items, major trading partners etc.

Data is dispersed in the survey so, let us make it easier for you. We will bring to you all the important data at one place as we cover economic survey chapter by chapter. In the meantime, start reading volume one from cover to cover for as I said before, they could be the best 150 pages you would ever read for exam purpose.