India's interventionist state: Reduce its scope, increase capability

Govt is increasingly keen to deliver even specific items like toilets, water, gas cylinders, where it can show the beneficiary immediate results. This new welfarism helps win polls but not development

The Karnataka Secretariat has the motivational inscription, “Government Work is God’s Work”, but if truth be told, god’s help is needed in most dealings with the government. The size of India’s government is not outlandishly large but its scope — degree to which it intervenes everywhere — is very wide and as a result, its effectiveness is low. Doing too many things badly leads to poor outcomes.

If India is to reset for the 21st century, modernising and reforming government will be vital. One way of improving the effectiveness of the state is to think of two stages: Reduce the scope A to B and then build up capability B to C (see figure).

Some look at our tax gross domestic product (GDP) ratio of 17 per cent of GDP and argue that the Indian state is too small. But total revenues have been in the range of 21 per cent of GDP and government spend remains at around 28 per cent of GDP — much higher than most countries at its level of GDP. As a result, the combined deficit of state and central government has been around 7 per cent of GDP. Financing this deficit has meant huge financial repression — as India has run a current account deficit of only around 2 per cent of GDP, this has meant that around 5 per cent of combined government deficit was financed by domestic savings. Such large financing needs has meant substantial financial repression. A well-designed and implemented goods and services tax (GST) could have increased tax intake by as much as 3 per cent of GDP — but that opportunity was botched.

India underspends hugely on the basic functions of government — defence, basic education, primary health. Despite huge threats on India’s borders, real defence spend (leaving out One Rank One Pension, or OROP) at 1.5 per cent of GDP has been the lowest since Independence; and education and health spend need to go up by at least 4-5 per cent of GDP.

For what are considered intermediate functions of the state, India needs to move towards more commercialisation and private provision and free up resources for the basic functions. India can run a few Indian Institutes of Technology (IITs) and Indian Institutes of Management (IIMs) reasonably well but a mass of higher education institutions is basically providing degrees but no skills. For India’s growing higher education needs, a few more elite public institutions will not be enough. Incentives to create much higher quality private institutions will be critical.

Aircraft maintenance, airports, ports, highway maintenance, commercial banking, electricity, gas can be run either by the government or the private sector but as experience shows, in public hands if interfered with by political masters, these can also deteriorate quickly. Gradually, India is correctly moving to commercialise these types of services but the regulatory edifice for these must be kept simple, enforceable and predictable.

India underwent a phase of liberalisation after the 1991 reforms, which rid us of the Licence Raj but some 30 years later, the legacy of the public sector and government control remains large. And its new regulatory structure, increasingly captured by corporate interests, has reverted to a pseudo Licence Raj — a regulatory cholesterol but with wayward and often weak enforcement. Judicial activism is on the rise, triggered by unclear and overlapping laws and their capricious interpretation. A large public banking system remains, allowing the business-politician nexus enormous power, patronage and opportunity to shift downside risks to the taxpayer and derive huge profits on the upside. The decision to privatise two banks is the first signal of addressing this problem.

One principle that must be kept in mind is that more complex regulations can create more effective outcomes but it also requires much greater capacity to manage, implement and monitor those regulations. If that capacity does not exist, simplified and transparent regulatory structures and laws, with professional regulators with domain expertise, and more open stakeholder consultation should be considered. Civil society is often seen as an enemy by the state but instead can play a vital role not only in delivering services but also helping design and monitor regulations.

Getting the government out of business is the most obvious way of reducing its scope. India still has a public sector balance sheet with about 235 central public sector enterprises (CPSEs) and over 1,200 state-level public undertakings whose total assets exceed $500 billion (about 20 per cent of GDP). It must, over the next five years, convert a substantial part of this into a balance sheet of public infrastructure — transport, schools, health centres, sanitation — and crowd-in private investment for sustained long-term growth and poverty eradication. The recent announcement to privatise most PSEs is a step in the right direction but how transparently it is done, to whom are the assets sold and how the proceeds are used will matter.

India became a welfarist state before becoming a developed state. India now spends almost 4 per cent of GDP on subsidies (almost as much as it spends on public education and health) but also delivers them in a very ineffective manner with high leakages. Shifting to income transfers while allowing less government intervention in a range of product subsidies — food, fertilisers, pesticides, electricity — will ensure better outcomes, and allow more funding for health and education. Most middle-income countries shift from distortive product-based subsidies to more efficient and less corruption-ridden people-based subsidies as the infrastructure for direct transfers — mobile, bank accounts and ID — are made universal.

Instead, India’s central government is increasingly keen to deliver even specific items like toilets, water, gas cylinders, bank accounts, where it can show the beneficiary immediate results. This new welfarism helps win elections but not development. Such items should be provided by the private sector — and in any case, at much lower levels of government involvement — and not by the central government.

In this article, I have focused on reducing the scope of the state — the first stage of the reform. In a companion piece, I outline how to build state capability.

The writer is former Director General, Independent Evaluation Office, GoI, and Distinguished Visiting Scholar, George Washington University, USA

> Tomorrow: India’s interventionist state — Part 2