A new India

Economic systems can be broadly classified between market and non-market. A market system is one in which the market freely trades resources such as time, effort, land, materials, capital and energy, allowing these resources to be appropriately priced and be converted into usable things or services. Market systems have succeeded because they are efficient in allocating resources and generating maximum possible wealth. However, markets can be unfair. They invariably lead to wealth concentration since random outcomes are an important ingredient in outcomes. 

This doesn’t mean that non-market systems, where governments determine results, have been better because they are woefully inefficient. Contrary to popular discourse, non-market systems are also almost always unfair since they concentrate power and resources in a few hands. Given the greater efficiency of a market system, it is almost the choice du jour to run economies.  

The question then is: Can we make market systems fair? This issue of lack of fairness of markets became stark in the aftermath of the Great Depression in the US in the 1930s, and gave birth to a revolutionary thought process by one of the brightest economists of the past 100 years, Kenneth Arrow. He argued that we could make markets fair by adjusting the starting position without altering their efficiency for worse. Arrow’s theory proposed that governments collect taxes from rich people and distribute some of that money to poor people via subsidy programmes. This “head start” strategy neutralises the role of random positive outcomes in market systems, giving the left out or disadvantaged people a chance to compete. Kenneth Arrow won a Noble Prize for this theory.  

As appealing as Kenneth Arrow’s theory was, putting it in practice has proved challenging. Governments are neither good at collecting taxes nor at distributing subsidies — especially in poor countries. Corruption at all levels makes fairness very difficult to deliver. So while India has pursued the Kenneth Arrow model,  the results have been far from satisfactory. India’s subsidies have totalled around $500 billion over the past 30 years with a limited impact on poverty. The key reason is the way these subsidies have been distributed. India’s subsidy programme has been run largely on paper and documented in handwritten ledgers, and has combined with deep rooted corruption. Consequently, it did not reach the intended recipients. The government in the past also decided what poor people needed — cheap rice or fertilisers — and that is what poor people got — usually governments are not good at figuring individual priorities.  

Three major changes have set the stage for greater fairness in India’s market model. First, Aadhaar, the world’s largest biometric ID project to uniquely identify each and every Indian using biometric data of finger prints and iris scans, has now registered 1.2 billion Indians — an unprecedented success in world history for any public programme. 

Aadhaar allows individuals to verify their identities at almost zero cost — very important to any mass scale distribution programme.  

The second change was India’s financial inclusion programme, Jan Dhan, which opened bank accounts for the unserved. Since 2014, 300 million bank accounts have been opened, bringing a completely new class of previously unbanked people into the banking system. These people are largely the intended beneficiaries of government transfers. Now armed with bank accounts, they were in a position to receive benefits directly from the government, bypassing agents and avoiding leakage. Aadhaar enables such transfers, since it can uniquely identify beneficiaries.  

The third change is in India’s taxation system on goods and services. The Goods and Services Tax, or GST, is set to change compliance due to its online nature and the way input taxation works. The GST should help boost revenue by reducing evasion of taxes on both goods and services and income.  The government will then become a more efficient collector of taxes. 

While GST will cause tax revenues to rise, Aadhaar and Jan Dhan have already been successful in transferring money to poor people. Over the past three years, the government has significantly scaled direct benefits transfers or DBT. There are now 439 government schemes conducting transfers via DBT. Cumu­latively since F2014, DBT transfers have amounted to Rs 732 billion, saving the country about Rs 142 billion in leakages. The breadth of delivery is unprecedented in world history. A lot of the DBT is in cash. This opens up opportunity for the recipient to decide how to spend the cash rather than the government deciding. Thus, recipients may choose to educate their children or upgrade their homes instead of buying more rice.  DBT ensures intended people receive the money and disintermediates middle men, reducing leakage and  saving billions of dollars of tax payers’ money.  

Of course Aadhaar is not flawless. Several people — especially those most needing DBT — have suffered authentication problems. In October 2018, the Supreme Court verdict on Aadhaar delivered the punchline: The Court observed that while is it possible that there is some unfortunate exclusion of close to 0.2 per cent, it is better to work towards reducing the 0.2 per cent to 0 than to jeopardise the 99.8 per cent, many of whom are among the most marginalised and biggest beneficiaries of Aadhaar.  

For the first time in India’s history, there is an opportunity for the government to induce fairness in a market system by collecting taxes more efficiently without evasion and distributing them to poor people in a targeted fashion without leakages. This sets the stage for a virtuous cycle, which is that such fairness allows India to become more market oriented, which in turn makes India more efficient. This virtuous cycle of efficiency and fairness means higher growth, further reducing poverty.  We dare say India is on its way to once again becoming a dominant global economy. Indeed, we are forecasting that in 10 years, India will become the world’s third-largest economy. Fingers crossed.
 

The writer is managing director, Head of India Equity Research and India Equity Strategist, Morgan Stanley