What the Govt Should Do and What It Shouldn’t

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The government of India over the years, at least in theory, has tried to make the lives of its citizens comfortable, by trying to deliver various goods and services at a subsidised rate.

And it has failed miserably at it. The leakage is extremely high i.e. much of the stuff the government wants to deliver gets stolen before it reaches the individuals it is meant for.

54% of the wheat that the government distributes through the public distribution system gets siphoned off. So does 15% of the rice and 48% of the sugar.

And the stealing doesn’t end at rice and wheat. 40% of fertilizer, 46% of kerosene and 24% of cooking gas is also stolen.

The government suffers from what economists call a principal-agent problem. As Vijay Joshi writes in India’s Long Road—The Search for Prosperity: “The government…suffers from a ‘principal-agent problem’. Its functionaries (legislators, bureaucrats) may pursue their own agendas rather than act in the public interest. They may shirk their duties or feather their own nests.”

While politicians and high-level bureaucrats are a part of the government, they are not the ones that people of this country deal with on a regular basis. The people deal with low level officials, from clerks at the local transport authority who won’t lift a finger without being bribed to the shopkeepers running the public distribution system, throughout the country.

And the incentives of these individuals are not in line with the public interest. Hence, there is pilferage and the subsidies that are meant for the people of this country never reach them.

This leads to a lot of money being spent by the government getting wasted. It leads to the government having to incur a higher expenditure than it would have if things reached the people they were meant for.

It also leads to an active black economy, where everything that is stolen from the public distribution system, is sold in the open market, at a higher price.

So what is the way around this? Should the government stop subsidising the people of this country and in the process save the money that gets wasted? Not really.

As Joshi writes: “There is a crucial distinction to be made between on the one hand the state paying for goods and services and on the other hand the state producing goods and services. For example, ‘food security’ may be thought of in common usage as a ‘public good’. However, even if it is agreed that the state should pay for food security, it does not follow that the state should carry out the task of actually delivering food to people.”

The fact that the government tries to deliver rice, wheat, sugar, kerosene, cooking gas, etc., to people, leads to the principle-agent problem and all the corruption that follows. So what is the way out? As Joshi writes: “The state could enable the poor to buy food in the market, at market prices, by transferring purchasing power to them directly in the form of cash or food vouchers. A system along these lines may be more effective in reaching poor people, and also less corrupt. This example is not chosen at random: it is highly relevant to the problems facing India’s public distribution system(PDS) for food delivery.”

Such a system is already available in case of cooking gas. It’s called Pahal. In this case, the subsidy amount on a cooking gas cylinder is paid directly into the bank account of the individual, instead of the cylinder being sold at a lower subsidised price, as was the case earlier.

In late June, 2016, the finance secretary Ashok Lavasa, told PTI that the government had saved Rs 14,872 crore by paying the subsidy amount directly into the account of people, instead of trying to deliver the cooking gas cylinder at a subsidised amount. The government has been able to save money by being able to bring down the cooking gas cylinders being sold in black.

As the Economic Survey of 2015-2016 points out: “The Pahal scheme has been a big success. The use of Aadhaar has made black marketing harder, and LPG leakages have reduced by about 24 per cent with limited exclusion of genuine beneficiaries.”

The real benefit to the government and the citizens will come when the government is able to implement the cash transfer programme (or what it calls direct benefit transfer) to other areas, where the leakages are high. For this to happen, citizens need to have Aadhaar cards and these cards need to be linked to savings bank accounts.

A lot of progress has been made in the issuance of Aadhar cards. As the Economic Survey points out: “The current government has built on the previous government’s support for the Aadhaar program: 210 million Aadhaar cards were created in 2015, at an astonishing rate of over 4 million cards per week. 975 million individuals now hold an Aadhaar card – over 75 percent of the population and nearly 95 per cent of the adult population.”

An Aadhaar card is necessary in order to identify the right beneficiary. This helps in eliminating bogus identities, through which people claim subsidies. But for the government to be able to transfer money to individuals, the Aadhaar card needs to be linked to a bank account.

As of June 2016, the 22.3 crore bank accounts had been opened under the Jan Dhan Yojana. This is a huge jump from 5.3 crore bank accounts from September 2014. Nevertheless, a lot still needs to be done on this front. As the Economic Survey points out: “Despite Jan Dhan’s record-breaking feats, basic savings account penetration in most states is still relatively low – 46 per cent on average and above 75 per cent in only 2 states (Madhya Pradesh and Chattisgarh).”

The Economic Survey was published in February 2016. Given that some time has elapsed since then, the figures quote above would have improved since then. What also does not help is the fact that only 27 per cent of villages have a bank within a distance of 5 kilometres. This means that last mile connectivity is a problem.

This essentially means that if the government moves to cash transfers immediately in a whole host of areas, chances of people being left out because they do not have a bank account, are high. This needs to be set right in the years to come. Of course, it is easier said than done.

The savings from such a system, if and when it is in place, will be huge. As Nitin Gadkari, the road transport and highways minister recently said: “If bogus claims are removed from scholarships, pension, subsidies, ration cards and other schemes and these are linked to Jan Dhan Yojna and Aadhar, it will result in savings of Rs 1 lakh crore to the exchequer.” For all the leakages that happen, Gadkari might just be right.

The column originally appeared in Vivek Kaul’s Diary on July 8, 2016

Economic Survey: There Is A Very Compelling Case For India To Move To Cash Transfer Of Subsidies


Price subsidies have been a very important part of the Indian government’s plan of trying to bring down poverty in the country. This entails selling commodities like rice, wheat and kerosene, at a price significantly lower than the market price through the public distribution system.

But the question is, do these subsidies work? The Economic Survey for 2014-2015 had said that: “Prima facie, price subsidies do not appear to have had a transformative effect on the living standards of the poor, though they have helped poor households weather inflation and price volatility.”

What are the basic problems with these subsidies? Subsidies are regressive. This basically means that the rich households tend to benefit more from them than the poor for whom the subsidies are meant.

Take the case of cooking gas which the oil marketing companies sell at a loss and are in turn compensated by the government. It turns out that the poorest 50% of the households consume only 25% of the cooking gas.

Further, subsidies don’t reach those who they are meant for. Around 46% of kerosene which has to be distributed through the public distribution system(PDS) is lost as a leakage. This basically means that the kerosene is siphoned off by those running the shops that constitute the PDS and the government functionaries involved. It is then sold in the open market.

This story plays out across other commodities distributed through the PDS as well. Nearly 54% of the wheat meant to be distributed through PDS is lost as a leakage. Around 48% of the sugar and 15% of rice meant to be distributed through the public distribution system is lost as a leakage.

Fertilisers also face a similar leakage problem. As the Economic Survey of 2015-2016 released a few hours back points out: “The government budgeted Rs 73,000 crore—about 0.5 per cent of GDP—on fertiliser subsidies in 2015-16. Nearly 70 percent of this amount was allocated to urea, the most commonly used fertiliser, making it the largest subsidy after food.”

Subsidised urea has three kinds of leakages. As the Survey points out: “(i) 24 per cent is spent on inefficient urea producers (ii) of the remaining,4 1 per cent is diverted to non-agricultural uses and abroad; (ii) of the remaining, 24 per cent is consumed by larger—presumably richer—farmers.”

These are huge leakages which cost the government a lot of money. So what can be done about this? As the Economic Survey points out: “Cash transfers can directly improve the economic lives of India’s poor, and raise economic efficiency by reducing leakages and market distortions.”

The current model of distribution of subsidies is essentially very leaky. This has led to a situation where only 35% or Rs 17,500 crore of the total urea subsidy of Rs 50,300 crore reaches the small and marginal farmers, the intended beneficiaries.

It is estimated that 75% subsidy on agricultural urea has essentially managed to create a thriving black market in the Bangladesh and Nepal. As the Economic Survey points out: “Comparing urea allocation data with estimates of actual use from the Cost of Cultivation Survey 2012-13, we estimate that 41 per cent of urea is diverted to industry or smuggled across borders.”

Further, there is a huge black market for urea within India as well. “It is estimated that about 51 per cent of Indian farmers buy urea at above-MRP. In the three eastern states bordering Bangladesh, 100 per cent of farmers had to buy urea at above MRP in the black market. Similarly, in Uttar Pradesh, which borders Nepal, 67 per cent of farmers had to buy urea in the black market at above the stipulated MRP,” the Survey points out.
The simple answer to prevent this leakage would have been better policing. Nevertheless, as World Bank chief economist Kaushik Basu writes in An Economist in the Real World—The Art of Policymaking in India: “Trying to police such a large system by creating another layer of police and bureaucracy will come with its own problems of corruption and bureaucracy.” It also leads to the proverbial question of who will police the police?

The answer lies in coming up with a better design in order to deliver food grains, fertiliser and kerosene to the poor. Essentially, the role of the PDS shop owner needs to be cut down. The Economic Survey for 2014-2015 as well as the Economic Survey for 2015-2016 talk about direct cash transfers to beneficiaries of these subsidised commodities, instead of distributing them through the PDS.

Instead of distributing food grains, fertiliser and kerosene through the PDS shops, the intended beneficiaries need to be given money through cash transfers and be allowed to buy commodities from wherever they want to.

As the Survey for 2014-2015 pointed out: “Recent experimental evidence documents that unconditional cash transfers – if targeted well – can boost household consumption and asset ownership and reduce food security problems for the ultra poor.”

In fact, Basu explains this in some detail in his book through the concept of food coupons, which are again nothing but cash transfers. He envisages a system where the poor get food coupons or cash transfers and they then use that money to buy kerosene, fertiliser and food grains from any shop instead of just the PDS shop in their neighbourhood.

As he writes: “Note that since the stores get full price from the poor and, more importantly, the same price from the poor and the rich, they will have little incentive to turn away the poor away. Further, the incentive to adulterate will also be greatly reduced since the poor will have the right to go to any store with their coupons [or cash for that matter].”

This means that the PDS shops are also likely to sell good stuff, instead of trying to adulterate the commodities. Further, the siphoning of the food grains, fertiliser and kerosene will also come down.

The fear here is that the poor will use their coupons or cash for something else. But that risk is anyway there in the current system as well. The poor can sell the grain or the kerosene that they get and do something else with that money.

Also, as Basu puts it: “If they choose not to take the benefit in the form of food and buy something else, it is not nearly so counterproductive as the benefit going to owners of PDS stores as often happens in the current system.” The chances of that money being spent and benefitting the economy are higher.

For this system to work the government needs to be able to link the Aadhaar number to an active bank account, in which it can transfer money. As of January 2016, around 970 million Indians have Aadhaar numbers. In fact, linking Aadhaar numbers to bank accounts has worked very well in case of subsidised cooking gas cylinders where black marketing has come down. “The use of Aadhaar has made black marketing harder, and LPG leakages have reduced by about 24 per cent with limited exclusion of genuine beneficiaries.”

As the Survey points out:A number of states, like Andhra Pradesh and Gujarat, with high Aadhaar penetration and POS devices in rural areas might be good candidates to start pilots based on this model.” 
Let’s hope this happens on a larger scale than it currently is, sooner rather than later.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Huffington Post India on February 26, 2016