November 16, 2012

Sizing the Indian Government

A framework to think about the scale and scope of government

This column’s focus is on governance and economic reforms, and its avowed claim is that it will see both sides of any question. What better way to begin, then, than to examine two pieces of contrarian thinking on the size of the Indian state?

First we have Ritwik Priya in the Business Standard, who argues that India’s fiscal deficit, far from being too large, is in fact small when compared to most developed countries – the subtext being that, a developing country has more leeway for the government to spend and incur a deficit because eventually, this will be made up in economic growth. Then, we have Milan Vaishnav, who, in an article published in Caravan argues that the Indian state, far from being too large is in fact too small when one considers the essential functions the state needs to perform.

While we may quibble with some facts and claims in both articles, we must recognise that the basic thrust of both of them makes sense and it presents a case for liberals who traditionally believe in a small government to answer to. The paradox is this: Even a minarchist, who believes that the government’s role ought to be strictly limited to running the police force, the courts and defence, will, if he were to do an honest analysis, find that the size of the Indian government needs to be expanded in those areas. But much of the discourse by liberals involves scaling back the government, and indeed, in the lived experience of most Indians, the government is a constant, intrusive and a negative presence.

Part of the resolution to the paradox is that much of the government functions “off the balance sheet”.  A citizen of India who wants to avail of some service from India’s police needs to bribe them. The bribe is, of course, a cost to the citizen and a major part of the policeman’s earnings. If the citizen had paid the bribe amount in taxes and the policeman had received the same amount in his salary, it would have shown up as in the size of the government in Mr Priya’s calculations. That this amount is off the balance sheet makes no difference to the fact that the cost as perceived by the citizen is real. Of course, this transaction is extremely distortionary. While it is an unfortunate fact that citizens have to bribe policemen even for services that are rightfully due to them, it is also true that much of the services sold in these off-balance sheet transactions are extra-legal and often outright illegal – in other words, the services are also off balance sheet.

A citizen faced with illegal demands and harassment from government officials certainly perceives it as a cost. A major part of the reason why he silently bears this cost rather than contest extortionary demands in courts, is that the Indian courts are extraordinarily slow in dispensing justice, and that is partly because the courts are underfunded and under-equipped. Once again, what shows up as small government in Mr Priya’s fiscal calculations shows up as overbearingly large government when experienced by the citizen.

Such examples of the disparity between the scope and size of government as experienced by citizens and between what shows up as the size of government in most formal records, can be multiplied. Every time a citizen drives on poor roads wasting time and petrol or every time he has to hire security guards because he knows that he cannot rely on the police to secure the city, he is incurring a cost because of government failure. It is tempting then, to conclude that investing in a larger government, at least in its ‘essential’ functions, will pay off in a reduced burden on the citizenry.

Of course, things are a bit more complicated than that. While part of the reason why government departments are incompetent and corrupt is that government functionaries are underpaid, no one can argue that paying them higher salaries will automatically result in a competent and a clean administration. While it may be true that the citizenry should be willing to pay more in taxes if they require a better government, it is also true that the government’s  lack of legitimacy and competence makes it that much harder to convince the citizens to pay more. The lack of legitimacy and competence of government departments should be factored into any argument we make about what the government should or should not do. And finally, there are many areas, like meritless subsidies, where every right-thinking citizen should support a government scale back.

So, here is a framework that I would propose we use when thinking of the scale and scope of the government.

First and most importantly, there is a need to reform the government’s administrative infrastructure and its mechanism for oversight and accountability. Unless this is done, no reform in any other category will be possible or feasible.

Second, the capacity of the basic functionaries of the government i.e. the police and the courts needs to be expanded.

Third, there are many economic activities where the government needs to scale back. It does not need to be running Public Sector Undertakings. It also needs to scale back on the number of regulations that it imposes on companies and citizens. Labour Regulations and IT rules, both are examples of the government stretching itself in areas before it has the competence to do so.

Fourth, infrastructure is an area where the government needs to invest more. The mechanism of investment needs to take into account the inevitable issues of legitimacy and competence – it is probably better to provide funding and let the private sector build the actual infrastructure.

Fifth, removal of non-merit subsidies is an area where the government needs to scale back. Most sensible people would agree on this, except when the government actually tries to do it, arguments start taking place over which one is a merit subsidy and which one isn’t.

Sixth, there are safety nets. Here, it is hard to argue that there should be a scaling back, but there is certainly a case for simplification and better targeting. Should India have difficult-to-administer programmes like the PDS or should it opt for simpler programmes like cash transfers? Whatever the merits of either programme in the abstract, the reality of India’s administrative capacity makes the case for the latter.

Overall, both Mr Priya and Mr Vaishnav make good points in their articles. It is time to move beyond simplistic arguments about the size of the government in the Indian context, and to think of where the government needs to scale down or scale up, and how it should do either. Hopefully, the six categories will form a good starting point.

Photo: Meanest Indian

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