India's states are starving education to feed freebies. It will hurt

Far from empowering the poor, the proliferation of freebies could have the opposite effect, harming social and economic outcomes

In Indian fiscal federalism, states have the predominant responsibility for providing social services and share co-equal responsibility, along with the Union government, for economic services. Yet, when it comes to evaluating their fiscal performance, the focus invariably remains on their deficits and debt, and not on the quality of their public spending. In reality, the recent trends see a sharp deterioration in the quality of public spending as subsidies and transfers crowd out expenditures on empowering people and accelerating development.  Every political party promises more and more “freebies” for short-term electoral gains, thereby compressing expenditures on physical and human capital.

 

Surely, controlling deficits and debt are important for sustainable fiscal management. However, the basic premise of the decentralisation theorem is that macroeconomic stabilisation and redistribution are predominantly (not exclusively) Central functions. The founding fathers of the Constitution were aware of this and, therefore, placed a mechanism to restrict states’ borrowing.  Article 293 (3) requires states to seek the permission of the Union government if they are indebted to it.  Although the Twelfth Finance Commission emphasised the need for the Union government to move away from intermediation, it has continued to do so — the latest example being the long-term Union loan for capital expenditures advanced to the states at zero rate of interest. With the fiscal responsibility legislation fixing their fiscal deficit at 3 per cent of gross state domestic product or GSDP, the Union government is supposed to place the limit. Of course, some states exert pressure to expand the deficit envelope through off-budget borrowings, but the responsibility to enforce the limit squarely lies with the Union government.

 

Accumulating a large volume of debt places a burden on the states in the form of high interest payments, which crowd out more productive expenditures; therefore, it is desirable to contain it. But in a constrained fiscal environment, states continue to attempt expanding their fiscal space even when they recognise this burden. The focus of the evaluation of states’ fiscal management, however, should be the quality of expenditures on the public services they are mandated to provide, unlike in the case of the Union government, which is supposed to focus on macroeconomic management. If states continue to have large deficits and debt, the blame should be placed on the Union government’s inability to limit states’ borrowing at sustainable levels, which it is empowered to do. 

Thus, the performance evaluation of states’ fiscal management should focus on the quality of the public services they are mandated to provide. The proliferation of subsidies and transfers for electoral gains, which crowd out spending on social and physical infrastructure, has become a major concern.  Although redistribution is a legitimate function of the governments as markets do not undertake it, the decision to extend subsidies and transfers must take into account two important factors.  

 

One, the opportunity cost of proliferating subsidies and transfers. Two, whether any other policy intervention could achieve the same objective more effectively and at a lower cost to the economy. On the first, the opportunity cost lies in the benefits that people lose because the subsidies displace other more productive expenditures. There can also be a hidden cost to the economy in terms of distortions in relative prices caused by the proliferation of subsidies and transfers.  Second, what is the counterfactual outcome?  Can the objective of redistribution be better achieved by empowering people through investment in human capital rather than providing temporary succour? 

 

The evaluation of the quality of state expenditure in terms of “development” and “non-development” categories can be misleading. The classification is done based on whether the expenditure items are under social and economic services or general services. Most of the “freebies” are budgeted under social or economic services, even though they do not contribute to long-term development.  Similarly, not all non-development expenditures are wasteful — for example, on safety and security of people, ensuring property rights, and enforcement of contracts. These are part of general services that are essential preconditions for development. What is important in the Indian context is the need to spend on building physical and human capital. In this regard, there has been a steady deterioration in public spending.

 

Much of the increase in subsidies and transfers has been financed by cutting back expenditures on education and, to some extent, capital spending. Education expenditure by all states taken together is just about 2.2 per cent of GDP. In fact, education expenditure incurred by states as a ratio of GDP declined from 2.5 per cent in 2011-12 to 2.2 per cent in 2023-24. As a ratio of states’ total expenditure, it declined from 17.7 per cent to 15.5 per cent during this period. This is despite the increase in grants under the centrally-sponsored scheme.  

 

The common way of compressing educational expenditures is to stop the recruitment of regular trained teachers and instead, hire “guest teachers”, without the required training. The centrally-sponsored schemes are essentially specific-purpose matching transfers, and the objective of such transfers is to ensure minimum standards of service.  

 

However, the Sarva Shiksha Abhiyan, with its 42 interventions — including access and retention, quality, gender, equity, the requirement of 25 per cent seats in private schools for economically-weaker sections under the Right to Education Act, infrastructure development, and programme management — fails to achieve the objective of ensuring minimum service standards. 

 

The rich and the upper-middle classes, which are vocal and can influence policies, have exited the public education system and have embraced private education, leaving the poor to bear the burden of declining quality in public education. The consequence of declining quality is the creation of a society with a very high degree of educational inequality, which may lead to income inequality in the future. The disempowerment of the next generation of poor children could also become a source of social unrest.

 

Similarly, the ratio of states’ capital outlay-to-GDP has remained stagnant at 1.96 per cent over the past decade. However, if the interest-free loan of approximately  ₹1.3 trillion provided by the Union government for capital expenditures in 2023-24 is excluded, the ratio declines to 1.5 per cent.

 

In other words, the interest-free loan has allowed states to substitute capital spending from their own sources with Union loans by 0.5 percentage points to GDP. This will have an adverse impact on the growth and employment in the country. Thus, the proliferating freebies have a negative impact on the empowerment of the poor, which could also have serious social repercussions in the future. 

The author is chairman, Karnataka Regional Imbalances Redressal Committee. The views are personal