Price `100

Indian
Economic
Survey 2016
by CivilsDaily

1
Economic
Outlook,
Prospects, and
Policy Challenges

2
Having discussed how to read Economic Survey earlier, we now Similarly, skepticism about the state must translate into
start our series on economic survey chapter by chapter. We shall making it leaner, without delegitimizing its essential roles
follow a standard pattern across all chapters. We shall begin by and indeed by strengthening it in important areas
highlighting quotable quotes or observations which might not
otherwise come for discussion but nevertheless very important 3. Amid the world economy which is full of turbulence and vola-
for general understanding, general studies papers and essay. We tility, India is a refuge of stability and an outpost of opportunity
shall then present some very basic statistics from the chapter and
move to discuss broad themes of the chapter. In the end, import- 1. Survey projects GDP growth of 7-7.75% for the financial year
ant reading from the chapter shall be recommended. (FY) 17
2. For FY16, GDP growth is estimated to be 7.6%
Note that reform of 1991 was 3. Forex reseves have risen to >350b$

in response to major crisis,

India becoming more and more
SEBI was given statutory
intertwined with global growth
backing in response to major
the correlation between Indias growth rate and that of the
scam in stock market and world has risen sharply to .42 from .2 for the period 1991-
2002 i.e. 1 % decrease in the world growth rate # 0.42 %
recent merger of Forward decrease in Indian growth rates
Indias exports of manufactured goods and services now
Market Commission (FMC) constitute about 18 percent of GDP, up from about 11 per-
cent a decade ago
with SEBI was also a response
to major scam. Realizing long term potential
growth of 8-10% requires a push on
So lets get started
at least three fronts-
1. Its futile to expect Big Bang reforms because of two reasons
dispersed nature of power in India, too many veto centers Creating genuinely pro competitive market by allowing
the absence of that impelling drivercrisis inefficient firms to exit (Chakravyuha challenge) Govt
response- new bankruptcy code, rehabilitation of stalled
Therefore, persistent, creative and encompassing incremen- projects, Kelkar Committee guidelines on PPP renegotiation
talism will be the key. major investments in people health and education- to
exploit Indias demographic dividend.
2. Being pro industry and pro market or pro competition is not Dont neglect agriculture as 42% of Indian households
one and the same derive the bulk of their income from farming. Smaller farm-
India has moved away from being reflexively anti-markets ers and landless laborers especially are highly vulnerable
and uncritically pro-state to being pro-entrepreneurship to productivity, weather, and market shocks changes that
and skeptical about the state affect their incomes. Govt response PM Fasal Bima Yojana
But being pro industry must evolve into being genuinely pro
competition, and the legacy of the pervasive exemptions Raj
and corporate subsidies highlights why favoring business
(and not markets) can actually impede competition

3
Evolution of relative role of centre and states in the delivery They are also magnets because they attract resources, talent
of services- and technology away from the lagging states, forcing change
via channel of exit.
1. With increased devolution of resources (courtesy 14th
Finance commission), states need to expand their capacity
and improve the efficiency of service delivery. Twin Balance Sheet Challenge
2. shift the focus from outlays to outcomes, and to learn by
monitoring, innovating, and even erring. What are twin balance sheets Bank balance sheet and corporate
3. the Centre should focus on improving policies, strengthen- balance sheet
ing regulatory institutions, and facilitating cooperative and
competitive federalism Basically both are interlinked, as asset on bank balance sheet
4. while the states mobilize around implementing programs is liability on corporate balance sheet and if corporate does not
and schemes to ensure better service delivery repay debt, asset turns bad (Non Performing Asset or NPA) and
both balance sheets get stretched. It results in banks not lending
How does competitive federalism help? and corporate not investing resulting in vicious circle.

States that perform well are increasingly becoming models and Solution-
magnets.

What has been done so far Indradhanush scheme, Strategic

Successful experiments in one state are models for others Debt Restructuring (SDR) scheme, 5:25 scheme
states to emulate by showing what can be done and stripping
away excuses for inaction and under-performance. What needs to be done 4Rs

4
 Recognition- Banks must value their assets as far as possi-
ble close to true value i.e. recognize NPAs as NPAs
Recapitalization capital position must be safeguarded
via infusions of equity
Resolution the underlying stressed assets in the corporate
sector must be sold or rehabilitated
Reform future incentives for the private sector and corpo-
rates must be set right to avoid a repetition of the problem

But where would resources for recapitalization would come

from given that government is committed to the path of fiscal
consolidation?

Divest govt. equities in non financial companies and invest

in PSBs
Dilute RBIs capital to capitalize banks address a pressing backlog of infrastructure needs
govt can dilute its equity in banks to raise resources from current global environment is fraught with risks and India
the market should not take chances against growth

In this context it is important that government utilizes resources

What should be the stance of fiscal available to it to increase capital expenditure in roads, railways,
ports etc which increases overall productivity and competitive-
consolidation? ness of economy.

Govt announced revised FRBM timeline last year with fiscal

deficit target of 3.9% for FY16 and 3.5% for FY17. In this context India and WTO
question arises whether or not we remain committed to the same
path of fiscal consolidation. Two issues in agriculture-

Arguments for accelerated fiscal consolidation Special safeguard mechanism (SSM) which came for discus-
sion in Nairobi ministerial meeting . The question which arises
debt ratio of the consolidated government (Centre plus is whether India even needs such protection
states), 67 per cent of GDP is high compared to some coun- We are already allowed tariff from 40 per cent to 100 per
tries in Emerging Asia cent (Indias modal rate in agriculture) to 150 per cent.
would reinforce govts credibility In a preponderance of tariff lines, there is a considerable gap
also why such a commitment should be abandoned when between applied tariffs and the level of tariff binding
the economy is growing at more than 7 per cent Indias only real need for SSM arises in relation to a small frac-
Higher deficits may increase short term interest rates and tion of its tariff linessome milk and dairy products, some fruits,
thus hurt corporate investment and increase govt spending and raw hideswhere its tariff bindings are in the range of about
on interest 10-40 percent, uncomfortably close to Indias current tariffs, lim-
iting Indias options in the event of import surges
Arguments against- India should call for a discussion of SSMs not as a generic issue
of principle but as a pragmatic negotiating objective covering a
7th Pay commission award will increase expenditure by small part of agricultural tariffs.
about .5% of GDP, to maintain same fiscal deficit, govt might
need to slash capital expenditure Food security/ stockholding issue
Public investment may need to be increased further to

5
 The particular policies (MSP) which are being defended are
those that India intends to move out of in any case because ongoing stress?
of their well-documented impacts:
decline in water tables, over-use of electricity and fertilizers Chinese dumping, weak global environment, protectionist mea-
(causing health harm), and rising environmental pollution, sures abroad, beggar thy neighbor policies etc .
owing to post-harvest burning of husks
the government is steadfastly committed to providing direct Broad principle- resist calls to seek recourse in protectionist
income support to farmers and crop insurance which will measures, especially in relation to items that could undermine
not be restricted by WTO rules the competitiveness of downstream firms and industries. For
instance imposing higher duty on imported steel hurts domestic
The way forward in WTO on agriculture manufacturers such as cycle manufacturers and lead to inverted
duty structure.
India should consider offering reduction in its very high tariff
bindings and instead seek more freedom to provide higher levels Three sets of responses-
of domestic support: this would be especially true for pulses going
forward where higher minimum support prices may be necessary Exchange rate. Keep rupees value fair, avoid strengthen-
to incentivize pulses production ing using some combination of monetary relaxation, allow
gradual declines in the rupee if capital flows are weak, inter-
vention in foreign exchange markets if inflows are robust.
Indias big-but-poor dilemma India should strengthen procedures that allow WTO-con-
sistent and hence legitimate actions against dumping
Indias self-perception as a poor country translates into a (anti-dumping), subsidization (countervailing duties), and
reluctance to recognize and practice reciprocity (give-and- surges in imports (safeguard measures) to be taken expedi-
take) in trade negotiations tiously and effectively.
Indias policies have a significant impact on global markets India should eliminate all the policies that currently provide
and it has become a large economy in which partner coun- negative protection for Indian manufacturing and favor for-
tries have a legitimate stake in seeking market access eign manufacturing. Implement GST asap.

Net effect- India is unable to play reciprocal game in trade nego-

tiations and WTO is fast becoming irrelevant (not good for India)

Cost of reluctant engagement-

India is excluded from Trans Pacific Partnership (TPP) and

it is shaped in a way that do not take into account Indias
important interests (the rules on intellectual property)
If and when India joins, it will be not on Indias terms but
on terms already cast in stone, terms that India could not
influence because of being perceived as not engaged fully

What should be Indias response-

We should use our growing markets as leverage to attain our

own market interests abroad, including the mobility of labor
and engage in reciprocal game to strengthen WTO.

How should trade policy deal with

6
The
Chakravyuha
Challenge of the
Indian Economy

7
 A market economy requires unrestricted entry of new firms, What are the costs of impeded
new ideas, and new technologies so that the forces of com-
petition can guide capital and labour resources to their most exit?
productive and dynamic uses
But it also requires exit so that resources are forced or #1. Fiscal cost
enticed away from inefficient and unsustainable uses
Joseph Schumpeter expounded the concept of creative Of course, inefficient firms are supported by explicit
destruction, the process of industrial mutation that inces- (bailouts) or implicit (free power, reduced tariff, interest
santly revolutionizes the economic structure from within, subvention etc) government subsidies
incessantly destroying the old one, incessantly creating new High subsidies # high borrowings # high fiscal deficit # high
ones debt # high interest cost.
Add to this the tax revenue forgone, if efficient firms were
Structural impediments to Indias allowed to take their place i.e. Double whammy of low tax
and high subsidies
progress-
#2. Economic cost-
Problems of entry i.e. licence-quota-permit Raj
Market economy is supposed to allocate resources/ factors
It has been largely taken care of by- of production (capital and labour) in the most efficient way
towards most profitable ventures
liberalization(delicensing, end of permit quota system) , pri- Lack of exit leads to misallocation of resources with enor-
vatization (Divestment and end of public sector monopoly), mous costs for a capital starved country such as India
Globalization (FDI and reduced tariff ) reforms of 1991 Overhang of stressed assets on corporate and bank balance
New initiative of across the board FDI liberalization and sheets reflect same problem (remember twin balance sheet
Start up-Stand up programme aim to further liberalize the challenges, 4Rs solution discussed in part one) of difficulty
entry. of apportioning costs of past mistakes
But exit (chakrvyuah) remains the major challenge-
#3. Political costs

What is this problem of exit and Benefits of impeded exit follows to rich (firms are owned
by richie rich naa) # govt charged as pro rich # No political
whats its magnitude? constituency for reform measures (recall debate on land
ordinance)
Inefficient and unsustainable firms are not allowed to wind No action against willful defaulters # erosion of legitimacy
down their operations and exit from the market of regulatory institutions such as RBI
In a normal economy, old firms would be the ones that were
efficient, only then could they survive for that long and Lets take an example of fertilizer subsidies
hence should be much bigger in size than new firms
But in India avg 40 year old firm is just 1.5 times larger than Fiscal cost- .8% of GDP, much of which leaks abroad or to non-ag-
a new firm (8 times in US ricultural uses, or goes to inefficient producers, or to firms given
Worst part is that a decade back they were 2.5 times larger the exclusive privilege to import.
i.e. inefficient firms are not allowed to exit and they remain But precisely for these reasons it has proved politically impossi-
small ble to close the inefficient firms or eliminate the canalisation of
imports. Rich farmers have internalised the benefits and prevent
reforms

8
What causes an exit problem? #3. Ideas/ ideology

3 Is Very difficult to phase out entitlements especially in a

country with sizable poverty and inequality and one that
#1. Interests Power of vested interests which is aggravated by is a democracy
certain imbalances or asymmetry The objective is often laudable but once the policies and pro-
grams have been set in place, they are very difficult to reverse
Concentrated producer interests (a few losers stand to lose For instance, minimum support prices (MSPs) were envi-
by lot) v/s diffused consumer interests (individual benefit sioned as an insurance mechanism for farmers, but have
small but aggregate benefit large) become price floors instead, favouring some crops in some
Concentrated interests have more voice, backed by financial regions at the expense of other
power and often democratic political systems tend to give
disproportional influence to them (vocal minority v/s silent
majority) How to address the problem
In the case of administrative schemes, vested interests often
create a market of their own, planning their actions to ben- #1. Avoid exit through liberal entry: promote competition via
efit from it: put differently, this is a case of supply creating private sector entry rather than change ownership through pri-
its own demand vatization. Eg. BSNL, MTNL were not privatized but liberal entry
Bureaucratic inertia perpetuates persistence to private telcos
50 percent of schemes are 25 years old. extra vigilance is nec-
essary to ensure that schemes remain relevant and useful Advantage- It bypasses opposition from managers as well as
over time. And vigilance should probably increase in pro- labour interests.
portion to the longevity. (for these reasons only concept of
ZERO based budgeting was introduced) #2. Direct policy action- Frame better laws, align incentives with
the objectives
#2. Institutions Paradoxical situation of both weak and strong
institutions delaying exit Govt response a new bankruptcy law (solves weak institution
problem), amendment to prevention of corruption act (solves
Weak institutions strong referee institution problem), reforms in PPP (Kelkar
Committee Report)
Inability to punish willful defaulters (legitimacy of institu-
tions itself is questioned) #3. Technology and the JAM solution: Direct Benefit Transfer
Judiciary- Tareekh pe Tareekh (time and cost overrun) (DBT) for targeting and protecting the poor while removing dis-
g. Debt recovery tribunal- share of settled cases is small and tortions
declining (4 lakh crore locked up)
Strong institutions so called referee or vigilance insti- Brings down human discretion and the layers of intermediaries
tutions CBI, CVC, CAG, Judiciary combined with the Breaks the old shackles and old ways of doing business
asymmetric incentives for bureaucrats that favours abun- #4. Transparency: Transparently reflect economic as well as
dant caution and hence the status quo. social, environmental and health costs and benefits
Incentives are stacked against decisions to precipitate exit
for fear of being seen as favouring corporate interests and Eg. Costs of producing cereals in Punjab and Haryana; declin-
hence susceptible to scrutiny, encouraging ever-greening of ing water table, soil quality degradation, post harvest burning of
loans, postponing exit

9
stalks causing pollution, rich farmers getting benefits Result
v/s benefits from pulses; nitrogen fixation, lower import depen-
dency etc. The reluctance of government to accept responsibility for its own
#5. Exit as an opportunity- Its not the business of govt to be in delays in projects
business. For eg. loss making Air India The penchant for departments to appeal even fair and reasonable
arbitration awards or lower court judgments
Opposition from existing managers or employees interests; The tendency to raise tax disputes based on audit objections even
solution- earmark resources earned from privatization for com- if the tax authority disagrees with the auditor
pensation and retraining; The reluctance of civil servants to sell land or divest public enter-
credibly ensure that reservation policies will be maintained in prises
the privatized enterprise as well
convert part of land into land bank and develop industrial clusters Solution:
or in dense urban areas nurture start ups
Amendment to prevention of Corruption act (prs bill sum-
mary) to prevent prosecution for mere administrative
errors, differentiating cases of graft from those of genuine
A few more points about strong errors of decision-making
Providing investigative agencies with tools, skills and train-
referee institution problems ing to do a proper investigation of modern day financial
crime and corruption so that culprits do not go scot free
Prevention of corruption act (PCA) definition of corruption either
does not include words like corruptly or wrongfully i.e. Reexamine the cost of elaborate but largely ineffective and
no requirement of mens rea or guilty intent hence even a counterproductive vigilance machinery
benefit conferred inadvertently is sufficient to be prosecuted
For example, suppose an honest public servant makes, in
good faith, an error of judgment and undervalues an asset
which is being disinvested. Obviously that undervaluation
causes a pecuniary gain to the buyer of the asset and is not
in public interest, he is in way benefited but can still be pros-
ecuted.
Misaligned incentive structure external monitoring in the
public sector tends to be skewed towards bad decisions that
were taken rather than good decisions that were not taken
(i.e. opportunities that were missed).
This promotes a culture where avoidance of mistakes is
more important than the pursuit of opportunities

10
Spreading JAM
across Indias
economy
Data which you can quote in exam to buttress your point-
Lets come to the main issue of
975 million individuals now hold an Aadhaar card over
75% of the population and nearly 95% of the adult popu- Direct Benefit Transfer using JAM-
lation
Nearly one-third of all states have Aadhar coverage rates Suppose the govt wanted to transfer 1000$ to every Indian
greater than 90%; and only in 4 statesNagaland (48.9), tomorrow. It would require-
Mizoram (38.0), Meghalaya (2.9) and Assam (2.4)is pen-
etration less than 50% Ability to identify beneficiaries (Authentication / identifi-
Basic savings account penetration in most states is still rel- cation or first mile)
atively low 46% on average and above 75% in only 2 states Ability to transfer money to beneficiaries (bank account )
(Madhya Pradesh and Chattisgarh). Ability to withdraw money from bank accounts (accessibil-
only 27% of villages have a bank within 5 km ity to bank branches / last mile)
The Kenyan BC:population ratio is 1:172. By contrast, Indias
average is 1:6630, less than 3% of the Kenyan level First mile/ identification issues-
spatial density of BCs in India is 17% the Kenyan level
Mobile penetration-Only in Bihar (54%) and Assam (56%) Failure on identification front leads to leakage benefits
is penetration lower than 60% intended for the poor flow to rich and ghost households,
there are approximately 1.4 million agents or service posts resulting in fiscal loss
to serve the approximately 1010 million mobile customers It was due to administrative and political discretion involved
in India, a ratio of about 1:720 in granting identity proofs like BPL cards, driving licenses
and voter IDs (not giving BPL card to poor etc)
This contrast of bank account penetration and accessibility v/s Aadhaar uses technology to replace human discretion and
mobile penetration suggests that- can better help in identification

India should take advantage of its deep mobile penetration 3 Broad issues-
and agent networks by making greater use of mobile pay-
ments technology. Govt response- licensing of payment Targeting targeted subsidies are harder to JAM than
banks universal programs, as they require government to have
Mobiles can not only transfer money quickly and securely, detailed information about beneficiaries. For instance-
but also improve the quality and convenience of service Subsidies targeted at the poor (like food and kerosene)
delivery require government to know peoples wealth while a uni-
For example, they can inform beneficiaries that food sup- versal subsidy like LPG requires no such information.
plies have arrived at the ration shop or fertilizer at the local Beneficiary databases: to identify beneficiaries, the govern-
retail outlet

11
 3% subsidized LPG consumption, but 49% of subsidized
kerosene i.e. if excluded from LPG subsidy not much effect
on poor but exclusion from kerosene subsidy will hurt them
the most

Where next to spread JAM?

Policymakers should decide where to apply JAM based on two
considerations of-

Amount of leakages- subsidies with higher leakages will have

larger returns from introducing JAM
ment needs a database of eligible individuals in digital form Control of the central government-control of central
to be seeded with Aadhaar. Socioeconomic caste census government will reduce administrative challenges of co-or-
(SECC) data needs to be continuously updated to serve as dination and political challenges of opposition by interest
a baseline in sectors where data does not exist. groups (middle mile challenge)
Eligibility: household-individual connection, while Aadhaar Fertilizer subsidies (huge leakages) and within-government
is an individual identifier, some schemes such as PDS ration transfers (govt control) are two most promising areas for
are implemented at household level and spending priorities introduction of the JAM
of male and female beneficiaries are often different.

2. Middle mile- administrative challenge of coordinating gov- JAM Preparedness Index:

ernment actors and the political economy challenge of sharing
rents with supply chain interest groups. Aadhaar penetration, basic bank account penetration and
Banking Correspondents (BC) density are used as indicators
Within-government coordination: among various minis- for the indices
tries, departments, state govt., departments etc. Preparation across states is varied with urban preparation
Supply chain interest groups: distributors need incentives being better than rural one
before they invest in JAM infrastructure and if their inter- In urban areas, Madhya Pradesh and Chattisgarh show
ests are threatened, they would obstruct the spread of JAM. preparedness scores of about 70% while Bihar and Maha-
3. Last mile/ Transfer and Access issues (Bank account and rashtra, have scores of only about 25%
access)- failure here risks excluding genuine beneficiaries, DBT rural preparedness has an average score of 3% and a
especially the poor. maximum of just 5%(Haryana)
Beneficiary financial inclusion: Bank accounts and accessi- It is clear that last-mile financial inclusion is the main con-
bility to bank branches. straint to making JAM happen in much of rural India. Jan
In rural areas physical connectivity to the banking system Dhans vision must truly succeed before much of India can
remains limited, and BCs, banking correspondents and JAM
mobile money providers have not yet solved this last-mile
problem
What is this BAPU?
2. Beneficiary vulnerability: amount of subsidy consumed by poor
Biometrically Authenticated Physical Uptake
exclusion error risks increase when the beneficiary popu-
lation is poorer It is an interim solution while banking correspondent net-
For instance, the poorest 30% of households consume only works develop and mobile banking spreads

12
 Beneficiaries verify their identities through scanning their sources continues, because of the differential tax treatment
thumbprint on a POS (point of sale) machine while buying of commercial and domestic LPG (no tax on domestic
the subsidised productsay kerosene at the PDS shop just unsubsidized cylinders (after 12 cylinders) v/s upto 30% tax
like your biometric attendance machine on commercial cylinders)
BAPU preparedness is much better (12%) than for Rural
DBT preparedness (3%) Solution- apply the One Product One Price principle and equalise
taxes across end-uses
Remarkable success of LPG DBT scheme (PAHAL)

Way forward on JAM

In those areas where the centre has less control, it should
incentivise the states to-invest in first-mile capacity (by
improving beneficiary databases),deal with middle-middle
challenges (by designing incentives for supply chain interest
groups to support DBT) and improve last-mile financial con-
nectivity (by developing the BC and mobile money space).
States should be incentivised by sharing fiscal savings from
DBT.
Centre can invest in last-mile financial inclusion via fur-
Use of Aadhaar has made black marketing harder (commer- ther improving BC networks and promoting the spread of
cial establishments buying subsidiesd domestic cylinder) mobile money
LPG leakages have reduced by about 24 per cent with limited Regulations governing the remuneration of BCs need to be
exclusion of genuine beneficiaries reviewed to ensure that commission rates are sufficient to
However, diversion of LPG from domestic to commercial encourage BCs to remain active

13
Agriculture:
More from Less

14
India lives in villages and agriculture is the soul of Indian econ- Challenge of income- As we mentioned above avg
omy- Mahatma Gandhi income of farmer from agriculture is just 20000 per
annum.
Most of the worlds poor people earn their living from agricul-
ture, so if we knew the economics of agriculture, we would know
much of the economics of being poor.- Theodore Schultz, Nobel
laureate Lets discuss some major issues
As per NSS data avg annual income of the median farmer net with agriculture
of production costs from cultivation is less than Rs 20,000 (avg
per cpaita income at current prices is about 98000 per annum Productivity/ Yield- low productivity esp. in pulses is
in India) the central challenge facing Indian agriculture.
Consider the case of wheat and rice-

Post independence agricultural As already stated, Indian agriculture has become cereal cen-
tric and input intensive and these two crops are grown on
success most fertile tracts with irrigation facilities and corner bulk
of agri support available to all crops across country. Yet, if we
Chronic food shortages of 1960s (recall PL 480 programme) compare average yield of wheat and rice in India with China,
have given way to grain self-sufficiency (not nutrition self we find that
sufficiency) despite a two-and-a-half fold increase in pop- avg yields of wheat is 39% below China and in case of
ulation. rice 46% below that of Chinas.
In 1966-67, Indian wheat and milk production were just In wheat save for Punjab and Haryana, most states have
about 1/3 of US output. Contrast it with recent figures yield lower than that of Bdesh
with wheat output being 60% higher than Americas, while In paddy even Punjab trails behind yield level of China
milk output being 50% higher. (Result of green and white while other states trail behind even Bdesh.
revolution)
Now if we compare productivity in pulses of which India is
topmost producer, consumer as well as importer, yield gaps
This seems like a remarkable are even more stark.

success. Then, whats the problem On an avg, countries like Brazil, Nigeria, and Myanmar
have higher yields
with Indian agriculture? even the key pulse producing state of M.P. has 60% yield
of Chinas
Indian agriculture has become cereal-centric (wheat and
rice production to the neglect of pulses and oil seed produc- Take home message from above analysis-
tion even though demand for protein based items is rising)
It is regionally biased (Punjab, Haryana, western UP cor- Yield gap varies among states in India and we could
nering all agri subsidies) and input-intensive, consuming make rapid gains in productivity through convergence
generous amounts of land, water, and fertiliser within India
Input intensive cultivation means there is sharp decline in For instance, in pulses, if all states were to attain even
cultivable land available per capita as also much lower levels Bihars level of productivity, pulses production would
of water per capita increase by an estimated 41% on aggregate and we would
Challenge of climate change erratic monsoon, more fre- be self sufficient in pulses
quent flood and droughts

15
Why is pulses productivity so low (land related reasons) water by exporting water guzzling crops such as paddy,
sugarcane, cotton also meat (not exactly crop)
Most of the land dedicated to growing pulses in each state India now exports about 1 per cent of total available
is unirrigated water every year (demand of 13m people)
National output of pulses comes predominantly from un-ir-
rigated land Reason for inefficient use of water-subsidies on power
and water for agriculture.

Result water tables are declining at a rate of 0.3 meters per

Issue of Intensive use of water year

(problem of Indian agriculture Solution- shift to sprinkler and drip irrigation and rainwater
harvesting.
becoming highly input intensive)
Leverage MGNREGA labour to build rainwater harvest-
ing structures.
Although water is one of Indias most scarce natural accord infrastructure lending status to these new
resources, We use 2 to 4 times more water to produce a unit technologies (infra lending status decreases cost of bor-
of major food crop than does China and Brazil. rowing to invest in these technologies)
We have invested in flood irrigation method (canal and tube
wells) which is highly inefficient way of using water Govt. response Convergence of various schemes under
Also despite being water scarce, we are virtually exporting PM krishi Sinchai Yojana which will help in convergence of

16
investments in irrigation, from water source to distribution and
end-use i.e. at individual farm level. Issue of Minimum support Price
What is drip irrigation? (MSP) and Procurement being
A type of micro irrigation method in which perforated pipes cereal centric and regionally biased
are placed either above or slightly below ground and drip
water on the roots and stems of plants, directing water more while the government announces MSP for 23 crops, effective
precisely to crops that need it MSP-linked procurement occurs mainly for wheat, rice and
It reduces consumption of fertiliser (through fertigation cotton and indirectly for sugarcane via sugar mills
) and water lost to evaporation, and higher yields than Even in these crops majority of procurement is from Punjab,
traditional flood irrigation <Fertigation is the process of Haryana, Western UP.
introducing fertiliser directly into the crops irrigation Poor farmers aof Rajasthan and Jharkhand are not even
system.> aware of any such MSP policy
Problem in adoption of drip irrigation- high initial cost of Result Regional disparity, excess stock of wheat and pulses and
purchase and the skill required for maintenance. import and volatility in prices of pulses.

Solution- the increase in yields and reduction in costs of power Solution-reorienting agriculture price policies, such that MSPs
and fertiliser use can help farmers recover the fixed cost quickly. are matched by public procurement efforts towards crops that
Hence, provision for credit to farmers to adopt this technology. better reflect the countrys natural resource scarcities i.e. provide
higher MSP for those crops which we import such as pulses and
But there are teething troubles in agri finance as mentioned in oil seeds and at the same time procure thise crops so that MSP
last years economic survey box- policy is effective on the ground.

Problem of agri finance- One way we discussed in chapter two was to not only taking
economic but social and environmental costs and benefit into
40% of agri finance still by informal sector account while deciding MSP. Copy pasting from chapter two
26% by usurious moneylenders
Share of long-term finance i.e. capital loans in overall credit Eg. Costs of producing cereals in Punjab and Haryana;
going down over the years (70% in 1991 to 40% in 2011) declining water table, soil quality degradation, post harvest
Share of small loans decreasing (less than 2lakh rupee loan burning of stalks causing pollution, rich farmers getting
from 78% of total in 2000 to 48 % in 2011 and 10 lakh and benefits
above from 8% in 2000 to 28%in 2011) March rush ( jan to v/s benefits from pulses; nitrogen fixation, lower import
march quarter) in loan disbursal i.e. loan in lean season to dependency etc.
comply with PSL
More and more agri loans going to urban and metropolitan For cereals a system of Price Deficiency payment can be insti-
areas tuted
Implication of all this is that lending to agriculture is grossly
misallocated # largely to ;arge farmers # not being used for Under this system if the price in an APMC mandi fell below the
capital formation # worst of all may not even be going into MSP then the farmer would be entitled to a maximum of, say, 50%
agriculture. of the difference between the MSP and the market price. This
subsidy could be paid to the farmer via Direct Benefits Transfer

17
(DBT) Solution

For eg. If say MSP for wheat is 100 rs per kg. In present scenario, There is need of instituting performance indicators in uni-
govt would procure it at 100 no matter if market demand is very versities.
low and prices some 10 rs per kg. Farmer has no incentive to Improve investment as a proportion of agri GDP
switch to other crops to reflect market demand. securing participation from the private sector
instituting a system in which the winner is offered a pro-
But in price deficiency payment, he will receive only 10 + portionately large enough award for innovating desirable
(1/2*100-10) = 10 + 45 = 55 rs. It protects farmers while signalling agricultural traits (such as improving pules productivity
him to produce crops reflecting market demand. considerably) but the intellectual property rights of the
innovation are transferred to the government
Leverage mobile phones to provide timely information to
Issue of Agri Research and farmers
Leverage the potential of drones (UAVs) to provide cru-
extension cial information on crop health, irrigation problems, soil
variation and even pest and fungal infestations that are not
Agricultural extension is the application of scientific research apparent at eye level to farmers
and new knowledge to agricultural practices through farmer edu- Improve regulatory process to address concerns against GM
cation. Basically educating farmers about the latest technologies crops while adapting high yielding technologies
being developed in the labs i.e. lab to land linkage.
While Indian Council of Agricultural Research (ICAR) with
agriculture research universities played a key role in the Green
revolution. Of late agriculture research has been plagued by Agriculture market segmentation
severe under investment and neglect.
Last years economic survey mentions, effectively, India has not
Three key weaknesses one, not 29 but thousands of agricultural markets.

Agri education is weak in states due to (i) resource crunch, Why are so many markets bad?
(ii) difficulty in attracting talented faculty, (iii) limited link-
ages and collaborations with international counterparts, Whole capitalistic economy is dependent on trade, compe-
(iv) weakening of the lab-to-land connect; and, (v) lack of tition and specialisation and so many markets prevent that
innovation thus reduces overall welfare because it prevents gains through
Low investment in public agricultural research in India. As competition, efficient resource allocation, specialization in sub
share of agriculture GDP, it is even less than that of Bangla- sectors (everyone has to produce everything as they cant trade
desh and Indonesia with others resulting in jack of all trades master of none) and
Majority (63.5 per cent) of scientists have low to very low fewer intermediaries.
level of productivity If there were one common market, prices would be same from
Kashmir to Kanyakumari and Dwarka to Puri (dont add trans-
port and storage cost please).

18
Mother and Child
Despite the high economic growth during the last two decades, Narrow economic logic
India has not been able to improve its maternal and child health
indicators at the desired pace. We failed to achieve health goals Research has shown that countries with better maternal and
related to Millennium Development Goals(MDGs) and our infant health at takeoff grew faster over the subsequent
maternal and infant mortality remains unacceptably high. 20 years. <takeoff stages is similar to takeoff of an airplane,
slow growing economy suddenly starts to grow very fast. For
India is in the middle of a demographic dividend which is going instance, China post economic reforms in 1979>
to last till about 2035-2040 (25 more years or one more genera- Tomorrows worker is todays child or foetus and events
tion) and its imperative that we invest in human capital to reap which occur while a child is in the womb i.e inside pregnant
the fruits of demographic dividend. This will raise our long run mother or very young (<2 yrs) affect cognitive development
economic growth potential. and health status even in adulthood i.e. if todays child is
weak, chances are tomorrows worker would be less pro-
In this context, economic survey argues that given fiscal ductive.
constraint <we can only spend as much as we tax plus some
borrowing, never behave like arm chair pundits asking to raise Why does health of new born affects outcome much beyond
budgetary allocation for everything without raising any taxes or the childhood?
train fares or bus fares> and states limited capacity to deliver
public services <we know how state i.e. govts mess up almost the most rapid period of physical and cognitive development
every sector they get into, just see the performance of public in a persons life occurs in the womb <rapid development
schools i.e. state should not take tasks beyond its capacity; first phases are most susceptible to environmental insults>
improve capacity and then take additional tasks; just passing RTE Dynamic complementarities in human capital accumu-
or establishing 5 more AIIMS or IITs is not enough>, state should lation- it simply means one human capital for instance
invest in relatively low cost maternal and early life health and health would affect accumulation of other human capital
nutrition programmes. for instance education and training/skill in a dynamic way
and vice versa. For instance healthy mother # healthy baby #
learns better <cognitive development better in the womb as
Whats the rationale behind mother is healthy> and stays on in school longer. Or consider
# unhealthy mother # weak baby # learns less and stays in
investing in mother and child? schools for shorter period # less skilled and competent
research has shown that low birth-weight children benefit
less from early-life cognitive stimulus programs i.e. early
Intrinsic reasons it improves quality of life directly and we intervene the better i.e. investment in mother and fetus.
expands possibilities for the individual <if someone is not born very young children
healthy, chances are he would be unhealthy in later life as well> success of subsequent interventionsschooling and train-

19
 ingare influenced by early-life development increased losses in feces as well as due to high metabolism during
programs targeting younger children also appear relatively infections>
cheap in comparison to investments made in older children.
For instance, iodine supplementation is way more cheaper Quick statistics
compared to improving teacher quality or re-designing
institutions to raise school accountability <good for fiscally 48% of under 5 children are stunted (low height) compared
constrained govt.>, also requires less service delivery capac- to 39% in Sub Saharan Africa
ity from the state, for instance, improving teacher quality 43% are underweight compared to 20% in Sub Saharan
would require teacher training, monitoring that they actu- Africa
ally show up and teach in schools <investing in mother and 28% are born low birth weight compared to 13% in Sub
child good for capacity constrained govt.> Saharan Africa
This data is taken from Amartya Sens book An Uncertain Glory
which took data from UNICEF(2012). This condition of poor
The Dismal State of (Childs) Play nutrition indicators comapred to much poorer and war torn Sub
Saharan Africa is known as South Asian Enigma or The Indian
in India Paradox and the low status of women is cited as one of the expla-
nation.

3 quick points about height for age in India

there has been improvement over time in both urban and

rural India
there is a persistent rural-urban height gap which has not
closed over the past decade
despite the progress made, India remains a negative out-
lierour children are on avg shorter than healthy children
Consequences-height-cognitive development gradient

Greater the height, greater the cognitive development (of course

corrected for genetic potential for height not that because Chi-
nese are short they are less smart then tall Caribbeans)
taller Indian children are considerably better readers than
shorter ones (height proxy for nutrition which affects cog-
nitive development)
absolute reading ability has not increased over time i.e we
have not made much progress in addressing the nutrition
Height is a good proxy for early life conditions and height is deter- and education challenge
mined by early life environment and net nutrition. Clearly much more needs to be done to improve the nutrition
situation in India.
net nutrition is defined as the sum total of (i) the nutrition
available from the mother in the womb and during breastfeed-
ing, (ii) the quantity and quality of the food that complements The Dismal State of Maternal
breast milk from 6-24 months, and (iii) energy losses due to dis-
ease and infection, and poor absorption of nutrients. <part 3 is an Health
important cause of malnutrition in India due to open defecation
and subsequent infections resulting in reduced absorption and As we have already discussed first 1000 days of life (nine month
in womb plus 2 years) are most critical for a childs development.

20
They depend critically on maternal health (esp 9 months in the Improving Maternal Health in India
womb)
Clearly much more needs to be done to improve maternal health.
70% of infant mortality (children who die before reaching
their 1st birthday) is due to neonatal mortality(dying before Govt response-. The National Food Security Act of 2013 legis-
1 month). A leading cause of this is low birth weight which is lated a universal cash entitlement for pregnant women of at least
clearly due to poor maternal health and nutrition. 6,000 rupees.

Consider this data- But it will only be successful if families convert these payments
into more, higher-quality food and more rest for pregnant women
42.2% of Indian women are underweight at the beginning and to make sure it happens, the cash transfer could be paired
of pregnancy with education about how much weight a woman should gain
50% of pregnant ladies are anemic(low hemoglobin in during pregnancy and why weight gain during pregnancy is
blood) <data from An Uncertain Glory> important. <cash transfer plus health education>
Women from richer households in India start pregnancy
heavier,suggesting that resources are at least part of the
reason for low pre-pregnancy weight <poor #less to spend
on nutritious food #low pre pregnancy weight>
No surprises then that women in India gain only about 7 kgs Universal v/s conditional cash trans-
during pregnancy, substantially less than the 12.5- 18 kg gain that
the WHO recommends for underweight women. fers
Very very important sociological Should cash transfer be universal i.e given to every pregnant
women regardless of what she does with that money or condi-
insights tional on women performing certain tasks such as visit hospital
regularly, getting delivered in hospital, vaccinating her child etc
Use these observations in paper 1 (society) and essay. They will as in Indira Gandhi Matritva Sahiyog Yojana (IGMSY)?
certainly add value to your answers.
Conditional cash transfer seems better but it entails high admin-
reason for poor maternal health is that social norms accord istrative costs, delays and often lead to significant exclusion.
young women low status in joint households. <When com- Hence survey suggests the cash transfer should be given in a
pared across the same ages, till about age 35, fraction of single, lump-sum payment early in pregnancy to avoid delays,
underweight women exceeds that of men by at least 5 per- reduce administrative costs, and ensure that it is possible for the
centage points. > within-household nutritional differentials household to spend the money on better food during pregnancy.
are stark
lower status of younger daughter-inlaws in families. <chil-
dren of younger brothers in joint family households are Case for going universal and
significantly more likely to be born underweight than chil-
dren of their older brother> Chachas children more likely problems with conditional cash
to be born low birth weight than Taus<Tijori ki Key Badi
bahu ke haath mein> transfer
Indian firstborn sons are found to have a height advantage
over African firstborn sons, and the height disadvantage
appears first in second-born children, increasing for sub- 2013-2014 Rapid Survey on Children (RSOC) finds that a
sequent births<preference for healthy male heir> little less than half of the women aged 15-18 are underweight
Maternal nutrition is so poor that Indian women actually

21
 weigh less at the end of pregnancy than sub-Saharan African Govt. response- swatch Bharat Abhiyan
women do at the beginning
Government should put new emphasis on educating women In the last year alone, the government built over 80 lakh
and their families about weight gain during pregnancy toilets
It should combat the common, though false, notion that UNs Sustainable Development Goals commit to ending
women should eat less, not more, during pregnancy<need open defecation worldwide by 2030
for health education> Historically, open defecation in India has declined by about
But conditional transfers solve only demand problems while 1 % per year <about 50 years before India becomes open
India chiefly faces supply problems i.e. unavailability of defecation free>. We need to more than triple the rate of
health services. reduction to achieve SDG. For that, it is important to under-
Also the need to document the fact that conditions have stand barriers to toilet adoption in rural India and promote
been met invites corruption<health worker might not give latrine use <as we just learnt, it;s much of a sociological,
the women the proof of attending health clinic without a behavioral problem>
bribe>
With careful design and significant investment of state
capacity, maternal health could be significantly improved
during pregnancy. Influencing social norms to make
investment yield better return
The problem of open defecation
A big challenge is deeply entrenched norms and facilitating
Facts-open defecation in India is much more common than in behavioural change. One can build clinics in villages or transfer
even much poorer countries <61% in rural India v/s 37 % Nepal,
32% rural Sub Saharan Africa, just 1.8% BDesh>

Only lack of toilets or income constraints is not the reason, but

there are sociological reasons

Fact- many people in rural India who live in households that con-
tain working latrines that are in use by other household members
nevertheless defecate in the open.

Research suggests that rural Indian households reject the types

of latrines promoted by the WHO and the Indian government
partly because their pits needed to be emptied every few years
and empty the latrine pit is associated with the strong notion
of purity and pollution <history of untouchability- work of dis- money to pregnant mothers or build latrines, but how does one
posing of human faeces is associated with severe forms of social bring out the right usage of all this physical capital ?
exclusion and oppression>
Consequences- disease, diarrhoea, environmental enteropathy Govt has a progressive role to play in changing norms, and thus
(reduced absorption of food) resulting in less amount of net the importance of high pitch campaigns such as Swatch Bharat
nutrition available to kids as we discussed above. Abhiyans.

Building toilets and ensuring people defecate in the open is an The government has recognised the importance of influencing
example of public good as even those who dont defecate in the social norms in a wide variety of sectors
open get sick due to germs from people who defecate in the open.
persuading the rich to give up subsidies they do not need
Addressing open defecation (give up lpg subsidy campaign)

22
 reducing social prejudices against girls (selfie with daughter)
educating people about the health externalities of defecating
in the open (swatch bharat)
and encouraging citizens to keep public spaces clean (swatch
Bharat)

Way forward-

Invest more resources in understanding the behavioral pat-

terns and how to change them
Create a Nudge unit within government for behavior change
communication as other countries have done

23
 Bounties for the
Well-Off
Performance of a subsidy programme can be judged on two cri-
teria

Equity- i.e subsidizing those goods and services that account

for a large share of expenditures of poorer households <for
instance food account for >50% share of household budget
of poor but very little share of rich, subsidisng food or not
taxing it at all will be proportionately more beneficial for
poor than rich>.> On the other hand subsidizing a good/
service such as airfares/ ATF (aviation turbine fuel) which
is mostly consumed by rich will not benefit the poor and
thus will not be equitable>
Effectiveness depends on how well targeted the subsidy
is .Suppose a good is consumed by poor such as kerosene
but also used in other industries <adulterating diesel for
instance>, not targeting well will result in leakage. Higher First things first, these are not just small. There are three types
the amount used by non targeted goods, lesser the effective- of schemes-
ness of subsidy.
actually small schemes- Eg. postal deposits, schemes for
Based on these aspects, lets discuss the bounties for the well off the elderly and women <poor people deposit small amount>
by the govt. notso-small schemes- Eg. Public Provident Fund (PPF)
<generally tax payers deposit upto 1.5 lakh rs limit i.e not
The government spends nearly 4.2% of GDP subsidising various so small amount and tax payers are at the top 5% of income
commodities and services. this data is from last years economic distribution in India i.e not at all poor, not even middle but
survey. This considers all implicit as well as explicit subsidies at rich>
both central and state level such as subsidised passenger fares, not-small-atall schemes Eg. tax-free bonds issued by
subsidised electricity etc. This is not how subsidies are shown Public sector Companies <generally rich people deposit on
in the budget. As we discussed in the fiscal policy article, govt avg 6 lakh per person i.e not small and poor dont have 6
budgets about 10% of expenditure as subsidies i.e about 1.6% of lakh rs to deposit>
GDP (only major explicit subsidies are considered there). Moral of the story so far is that we should not grudge first
type of small schemes (post office savings schemes) for they
Case of small savings These schemes were created to mobilise are for the really needed i.e equity principle holds true.
saving by encouraging small earners to save, and offered above
market deposit rates in accessible locations like post offices. But the benefit these schemes confer are much beyond the dif-
ference b/w rates of interest. Actual benefit is because of tax
We discussed that one distortion of small savings rate where rate concessions and here they become even more iniquitous <poor
is decided by govt is incomplete transmission of monetary policy even middle income groups are so poor, they dont pay income
(click here to read more about monetary policy and transmission) tax. Only top 5% of population pay income tax>
by banks but the issue here is are these schemes even benefiting
small savers i.e. poor.

24
How are savings taxed? tion. IN developed countries, greater proportion of population
pay taxes and thus these schemes benefit middle class as well.
Savings can be taxed at three stages

Contribution stage <when you deposit the amount> So how should savings be taxed?
Interest accrual <interesting earnings>
Withdrawal stage<when you take out principal and interest> Case for concessional tax treatment of savings -tax con-
cession for savings # higher post-tax return for the investor #
Income tax is inherently biased against savings; it leads to double positive substitution effect in favour of savings rather than cur-
taxation in so far both the savings and the earnings are taxed <tax- rent consumption. <higher savings # higher investment # good
ation of deposits as well as interest earnings>. So to eliminate this for economy esp for a capital starved economy like India>
bias and promote savings, tax incentives are given. So savings
may not be taxed at all in what is known as EEE (exempt exempt But problems with the way scheme is designed in India
exempt) i.e exempt from taxes at all three stages of taxation. Or
It also creates a disincentive for savings (income effect),
since the higher returns now require lower savings to meet
the lifetime savings target. <If a person needed to save 1lakh
rupee for his old age, he now will have to invest less to save
equivalent amount>
Tax incentives for savings, as designed in India, do not
encourage net savings (contribution plus accumulation
minus withdrawals) since withdrawals are also exempt
from tax <no incentive not to withdraw full amount at the
maturity>
Tax incentives for savings distort the interest structure and
choice of saving instruments. They just divert funds to spec-
they can be taxed at deposit and earning stage (TTT). Or tax at the ified savings instruments.
time of withdrawal only (EET) or making earnings tax free (TET) They also increase the interest rate at which households are
willing to lend funds to banks (i.e., make deposits) , thereby
Note that, TTT or TET does not mean you are tax both at the time adversely affecting investment.<depositors wont lend to
of deposit and withdrawal. Same income wont be taxed twice. banks at lower rates hence banks unable to pass rate cuts
Hence taxation at the time of contribution is deemed to be taxed to consumers>
at the time of withdrawal. regressive as they provide relatively higher tax benefits to
investors in the higher tax bracket; in fact, the real small
Lets understand this with example savers, who are largely outside the tax net, do not enjoy any
form of tax subsidy on their savings.
Clearly EEE scheme (provident fund) and TET (tax free bonds) Overall, tax incentives for savings, more so as designed in
give higher returns. Survey calculates that implicit subsidy is India, are economically inefficient, inequitable and do not
about 6% (R 12,000 crore) on Provident fund (not so small sav- serve the intended purpose. Hence, there is a strong case
ings) and 3.7% on tax-free bonds (not at all small saving and for review of the design of the tax incentives for savings
investment by largely rich). schemes.

This is based on data that only 5.8% of population earns more Economic survey suggests EET method of taxation for
than 2 lakh rupees to come under income tax net. Even more following reasons-
starkly, major benefit is reaped by those in 30% tax bracket
(income more than 10 lakh) who are among top .5% of popula- savings (contribution) reduce cash flow # the ability to pay

25
 # taxation would create hardship # disincentive to save.<if ATF- Theres no point subsidizing ATF or taxing it less than
I save 100k, consumption decreases by equivalent amount diesel for no poor travels by air. Yey ATF tax is 20% compared to
and over that govt taxes me, why would I save>. Taxation 55% for diesel and industry still keep clamoring for lower taxes
at the point of withdrawal (principal or earnings) occurs on ATF.
when the ability to pay is greater and therefore, justified on
principles of taxation <after all, now my income is actually Kerosene 50% of PDS kerosene is consumed by better off.plus
increasing> adulteration etc
TEE # taxation at the point of contribution # no immediate
incentive to save # exemption of withdrawals # encourages If we add it all total subsidy to well off comes out to be more than
withdrawal. Under EET # full deduction at the point of 1lakh crore i.e 16b$ (.8% of GDP).rupees and we havent yet added
contribution and accumulation # incentive for savings # corporate tax exemptions. Contrast this with expenditure on
taxation at the point of withdrawal # disincentive for with- health, a merit good, social responsibility of govt, just 1.3% of
drawal. GDP.
TEE # withdrawals are exempt irrespective of the amount # Addressing these interventions and rectifying some egregious
no incentive for consumption smoothening <will withdraw anomalies may be good not only from a fiscal and welfare per-
the whole amount in one go>, Under EET # More you with- spective <more govt budget for actual needy i.e poor>, but also
draw # come under higher income tax bracket # withdraw from a political economy welfare perspective, lending credibility
in staggered manner # consumption smoothening to other market-oriented reforms. <govt is pro rich barbs when-
no uncertainty about the potential tax liability ever any market oriented reforms are undertaken> It is also an
extremely simple in terms of compliance and administra- opportunity foregone to help the truly deserving.
tion
most developed countries and many developing countries Criticism of this analysis (personal views)
are implementing the EET method of taxation of savings
Higher taxes on gold hurts the jewelers. But most impor-
tantly promote black marketing, black money generation
Other bounties and corruption <people will buy gold at cheaper rate in Thai-
land and smuggle to India>
Case of Gold-Top 20% consumes 80% of gold yet gold is taxed at People earning 2 lakh rupees or 5 lakh rupees can not be
rate of <2% compared to standard tax rate of 26% (centre + states) termed super rich by any stretch of imagination.5 lakh per
annum for a family of 5 turns out to be kust 1lakh per capita
Railways Reserved class is hardly used by poor (bottom 30%), i.e 8k rupees per person per month. Problem is with super
yet upto 34% of reserved class fare is subsidized. rich(top .1%, not even 1%) and high amount og agri income
not being taxed(issue addressed in next chapter)
LPG-91 % of subsidies are accounted for by the better-off as their Political economy argument-Just as govt reduced interest
share of consumption of LPG is 91% compared to 9% for poor rate on provident funds, barbs of pro rich, pro-corporate
(bottom 30%) started being labelled on govt. Fact is that voice of vocifer-
ous minority(salaried middle class, super rich according
Electricity Better off are subisdized about 32% of electricity bill to survey) is much more than silent minority(poor) as we
while poor about 49%. But since 84% of electricity consumption discussed in chapter on exit problem.
is by better off, acutual subsidy amount will be pretty high.

26
Fiscal Capacity
for the 21st
Century
What is Fiscal Capacity?
Its simply ability to generate revenues. As majority of the rev-
enue of governments around the world is through taxes (other
from various fees/user charges/ dividends etc), Tax to GDP ratio
is often taken as proxy for the fiscal capacity of a govt.

Survey argues that state capacity and taxes are crucial

determinants of long run political and economic develop-
ment. But Why?

Govt can only spend as much as it earns (plus some limited

amount of borrowings). So fiscal capacity i.e tax to GDP ratio
also determines its spending capacity.

Political development-If spending is about the entitlements of

citizenship in a democracy, taxation is about the obligations of
citizenship <rights and duties>. As more and more people come
into the tax net via some form of direct taxation <in indirect What is citizens role in this contract?
taxation, people dont feel like they are paying. Dont we all gen-
erally think, only some 4% of India pays tax while every one who The citizens part of the contract is to hold the state account-
buys something pays some form of indirect tax>, they will more able when it fails to honour the contract <provide essential
actively take part in nation building<their money is at stake>. services and redistribute to reduce inequality>
But a citizens stake in exercising accountability diminishes
Economic development- Democracy is a contract between the if he does not pay in a visible and direct way for the services
state and its citizens. The states role is to create the conditions the state commits to providing <esp essential services. He
for prosperity for all by providing essential services <such as law is not paying, what does he care if state does not provide>
and order, enforcing contracts, roads, transport, health, educa- If a citizen does not pay he either becomes a free rider (using
tion etc, for instance without enforceable property rights markets
cant function> and protecting the less well-off via redistribution
<subsidies etc, providing minimum standard of living and reduc-
ing inequality>

27
 the service without paying) or exits (not using the service at For instance, there has not been a single famine in inde-
all). Both reduce the accountability of the state. pendent India <Amartya Sens famous theory that famine
For instance, not many taxpayers send their children to state simply dont occur in democracies as they cant afford it.
run schools i.e exit from the service, thus reducing account- Govt will simply lose power after a famine> but malnutrition
ability which leads to further deterioration in the quality remains a major challenge <discussed in chapter 4, women
of schooling. They simply dont have stakes in the system. and children>. <Reason is simple, malnutrition is not as
Thats why some promote banning or reducing to the min- dramatic as famine so doesnt attract media attention and
imum the role of private sector in primary education. And in India accountability is episodic not ongoing>.
it is for this reason that Allahbad High Court ordered public Or the Indian state can organize mega-events <common-
servants to compulsorily send their kids to Public school. wealth games, gigantic elections> but routine safety for
Indian express link here <whether order was complied with women is not ensured.
or not, I have no idea, May be UP wale can help us> Or state responds effectively to floods and tsunamis but
finds water and power metering more challenging <can not
Taxation is not just about financing public spending, it is the perform routine tasks which calls for ongoing accountability
economic glue that binds citizens to the state in a necessary two but performs heroically in dramatic events which remain in
way relationship. public memory and thus public enforces accountability at
the time of election i.e periodic accountability>

Precocious Indian phenomenon So does India tax and spend less as

of economic development lagging liberals/ left leaning commentators
political development (Amartya Sen and Dreaze argue)?
In terms of democracy index, India is highly developed with peri-
odic free and fair elections, a very noisy and vibrant democracy
but in terms of economic development India lags far behind the
OECD countries.

Difference in taxpaying <only 4% of voting age population paying

direct tax> and voting <universal adult franchise with >60%
voting> might explain the phenomenon in India of there being
reasonably effective episodic accountability <regular elections
with non performing govts being shown the door> as opposed to
ongoing accountability <reflected in corruption, law and order
problem>.

28
 India taxes (16.6%) and spends (26.6%) less than OECD if the states role is predominantly redistribution, the middle class
countries (34% and 43%) and less than its emerging market will seek to exit from the state, will avoid paying taxes and coccon
peers (21% and 31%) themselves in walled communities <states redistribution role
For its level of economic development (countries with sim- is perceived as illegitimate as they pay taxes but state cant even
ilar per capita income), India does not tax and spend less provide them essential services such as infrastructure, law and
But controlling for both the level of economic and politi- order, decent primary education>
cal development (democracy), India seems to tax less and As we saw earlier, in India they already send their kids to pri-
spend less and this is most significant with respect to social vate schools thus reducing the pressure on the state <ongoing
expenditure (on health and education) accountabilty is absent, lower class i.e poor are unable to hold
India spends on average about 3.4 percentage points less vis- state accountable for they dont even have enough time to invest
-vis comparable countries on health and education <thats a in these matters>. They thus reduce accountability and legiti-
huge amount, India spends about 3.3% of GDP on education macy of state even further.
and 1.3% on health i.e 4.6% total while comparable democ-
racies at similar level of economic development spend 8% A state that prioritises or over-emphasises redistribution without
on health and education> providing basic public goods, risks unleashing this vicious spiral.
Democracies tax and spend more, in part because they face Point is that India should invest more in essential services, law
greater pressures to redistribute and India lags behind here. and order, infrastructure, pollution, congestion, health, educa-
Indias tax to GDP ratio has increased by about 10% over tion to earn the legitimacy before taking on big re-distributive
the past six decades from about 6% in 1950-51 to 16.6% in role.
2013-14 (very slow growth)

This analysis seems like indictment of the Indian development Number of taxpayers in India (Too
experience since India has been a democracy for nearly 70 years.
But in most of the advanced democracies, the big increases in few or adequate)
fiscal capacity have been in response to wars (world wars) or
in response to extreme crises (Great Depression of the 1930s) In India roughly 5.5% of earning individuals or 4% of voting age
which led to a sharp expansion of the welfare state and the need population is in the tax net.
to finance it. Independent India has not experienced shocks of
such large magnitudes that created pressures to enhance state Controlling for level of economic development, India does not
capacity. have too few taxpayers but again if we compare India with coun-
western democracies have also had a much longer period of polit- tries with similar level of income but those who are democracies
ical evolution <USA became republic in 1789 v.s Inda in 1950> (political development), India seems to have too few taxpayers.
allowing them to build state capacity <taxation and expenditure It should be 23% while India only has 4%.
institutions>

Now that we have established India taxes and spends less Top personal income distribution
compared to other democracies, should India start taxing
and redistributing more? (Inequality in India)
The history of Europe and the US suggests that typically, states Inequality is generally measured by Gini coefficient (more on
first provide essential services (physical security, health, educa- that in separate back 2 basics economics article some other day).
tion, infrastructure, etc.) before they take on their redistribution Other measure is to compare income of top quintile (20%) with
role. Why? bottom quintile (20%). But of late, greater focus has been on
Because unless the middle class in society perceives that it income and wealth of top 1%, even more of top 0.1%.
derives some benefits from the state, it may be largely unwilling
to finance redistribution We can see from the figure below that increasingly there is greater
In other words legitimacy to redistribute is earned through a concentration of income among top 1% and even more so among
demonstrated record of effectiveness in delivering essential top 0.1%. In 2012 top 0.1% held 5.1% of national income up from
services

29
3.6% in 1998. its economic costs but also because it undermines legitimacy<if
citizens think public resources i.e their hard earned money going
for taxes is being wasted, they would try to avoid paying taxes>
Moving To A Better Equilibrium Subsidies to the well-off (1 lakh cr, disccused in chapter 6) need
to be scaled back.
On Taxation And Spending Tax exemptions Raj which often amount to redistribution
towards the richer private sector will also need to be phased out.
India has not fully translated its democratic vigour into commen- <govt announced phasing down of exemption and reducing taxes
surately strong fiscal capacity <As we saw India taxes and spends but not much guidance from the budget>
less among democracies> Reasonable taxation of the better-off, regardless of where they
get their income fromindustry, services, real estate, or agricul-
Reform through inaction Do not increase exemption threshold. turewill also help build legitimacy<presently agri income is not
As income rises, more people would automatically come into tax taxed and we all know politicians show all their black income as
net. income from agriculture and plantation>
Property taxation needs to be developed. Property taxes are espe-
Additional 1.65 crore people would have been in the tax system cially desirable because they are progressive <rich owns more
and tax-GDP would have increased by 0.32% by 2013 if govt had property, will pay more>, buoyant and difficult to evade, since
not raised exemption threshold from 1.50 lakh to 2 lakh. they are imposed on a non-mobile good, which can with todays
But beyond this low hanging fruit of not increasing exemp- technologies, be relatively easily identified.
tion limit, to increase fiscal capacity (tax more) state must also Higher property tax rates can be the foundation of local govern-
increase its legitimacy. ments finances, which can thereby provide local public goods
and strengthen democratic accountability and more effective
Governments spending priorities must include essential services decentralization. It would also put sand in the wheels of prop-
that all citizens consume: public infrastructure, law and order, erty speculation. Smart cities require smart public finance and
less pollution and congestion, etc.<so that middle class does not a sound property taxation regime is vital to Indias urban future.
exit v/s redistribution>
Reducing corruption must be a high priority not just because of

30
Preferential
Trade
Agreements
different FTAs in different sectors are different. For instance,
the India-Korea CEPA contains chapters on Origin Procedures,
Telecommunication and Audio-Visual Co-production, but these
are not included in the India-Japan CEPA. There are provisions
in India-Japan CEPA not included in Indo-Korea CEPA <this
all creates complications as number of FTAs increase and they
all have different rules, regulations and procedures> <What are
rules of origin? answer in the comments below>

Concept of spaghetti-bowl effect /

Noodle bowl effect

India and FTAs

India has long-standing commitment to multilateralism
under WTO agreements but in line with global trends, India
has made use of FTAs as a key component of its trade and
foreign policy. If WTO is going nowhere, we cant just sit and
expect WTO negotiation to conclude, we also have to sign
FTA or we will be left behind
So far, India has mainly focused on partnering with other
Asian countries, and in goods more so than in services <with
SL, Afghanistan, Thailand, Singapore, Bhutan, Nepal, Korea, Concept was propounded by worlds foremost trade economist
Malaysia and Japan and regional trade agreements SAFTA Prof Jagdish Bhagwati is analogy between the tangling of spa-
and ASEAN> ghetti or noodle in a bowl with the tangling of different FTAs, He
Outside Asia, We have signed FTAs with Chile and MER- argues that so many FTAs with their differential tariff rates, rules,
COSUR <What is MERCOSUR, answer in comments> procedures muddy water so much that leads to discriminatory
trade policy and results in often contradictory outcomes amongst
But not all FTAs are same and depth of integration offered by bilateral and multilateral trade partners.

31
Lets understand this with an example- Suppose rule of origin impact on Indias GDP from -0.1% to -.2%.
rule in TPP implies that Vietnam can only export textile which TPP/ RECP is very, very important topic for prelims/ mains/
is made from Vietnami Yarn. Now Vietnam has an FTA with interview. For prelims, name of countries in TPP, in RCEP, in
say Bdesh or India and Yarn is covered under it. Indian yarn is ASEAN, in all 3 grouping, in only 2 groupings etc is very import-
cheaper yet Vietnam will not buy it because textile manufactured ant. Look at the figure below, it will help you remember the names
from it will not be covered under TPP. Multiply it across more well
than 400 FTAs and you can understand how complex it can get
and more complex it gets, advantage developed and bigger coun-
tries.

Small countries dont have resources to investigate whether US is

actually following rules of origin for its exports. At much bigger
level, it would look like this

Its safe to say that developing countries like India should invest
their energy in successful negotiation of WTO rounds as they
can negotiate them better collectively, outcomes are not very
complex thus beneficial to less resourceful. But as we can not wait
for that to happen indefinitely we should also sign FTAs which
would be beneficial to us. Other way to remember the names is continent wise

4 ASEAN members- Malaysia, Singapore, Brunei ,Vietnam

Mega-Regionalism 7 RCEP members- 4 ASEAN above + Australia, New Zealand,
Japan
Until recently FTAs were signed mainly bilaterally and regionally 5 American countries Canada, Mexico, United States, Chile, Peru
<india-Bhutan, ASEAN ka SAFTA, North America ka NAFTA,
Europe ka EU> but of late PTAs have begun to morph into
mega-regional agreements, which would encompass a large share
of world GDP and trade. Consider for instance:

TPP- 40% of Global GDP and 33% of trade (already sgined)

TTIP- 50% of GDP and 30% of merchandise trade, 40% (3 from North and central America + 2 from South America)
trade in services (negotiations continuing) <TTIP is trans Please note that China and Korea are not part of TPP
atlantic trade and investment partnership b.w EU and USA> For detailed analysis on TPP for mains/ interview purpose, please
read our blogs here- TPP decodified and RSTV summary, impor-
India is not a member of either of these two grouping but is nego- tance of TPP
tiating its own mega regional- RCEP (regional comprehensive
economic partnership) which is not as ambitious in scope as the
other two agreements. To PTA or Not to PTA?
With the signing of TPP and TPIP, India will have access to these Over the years, India has signed many FTAs, have they benefited
markets at higher costs <member countries will get preferential us? As number of FTAs and mega regional pacts are proliferating,
treatment; resulting in some negative impact on Indian exports should we sign more FTAs?
and thus our GDP growth. Different studies suggest negative
Any FTA will lead to increase in trade as tariff and non tariff

32
barriers come down but if it leads to much higher imports than Conclusion
exports and thus negative trade balance, impact can be consid-
ered as negative. FTAs have increased trade with FTA countries more than
would have happened otherwise.
Increased trade has been more on the import than export
Concept of trade creation v/s trade side, most likely because India maintains relatively high
tariffs and hence had larger tariff reductions than its FTA
diversion partners
The trade increases have been much greater with the
Another aspect of FTAS which like Spaghetti bowl effect is a crit- ASEAN than other FTA.
icism of FTAS wrt WTO- whether actually trade is being created
or is it merely shifting to inefficient firms?
What should be Indias stance
Trade creation -In WTO, a country reduces tariff for every other
country in this world and because of this tariff decrease, outside towards FTAs and mega regional
firms can compete with domestic producers and trade increases
leading to trade creation. trade agreements?
Trade diversion occurs when tariff preferences offered under Multilateral trade liberalisation remains the best way for-
an FTA causes a shift of imports from firms in non FTA member ward
countries to less efficient firms within the trade bloc, which now But the WTO process seems to have been overtaken by pref-
become competitive due to tariff reliefs. erential trade agreements
Against this background, India has a strategic choice to
Lets understand this with an example- make: to play the same PTA game as everyone else or be
excluded from this process
Suppose country B is imports mangoes from country C and D, In the current context of slowing demand and excess capac-
Until now, it imposed 20% tariff on both, thus major market share ity with threats of circumvention of trade rules, progress
is captured by country D which is more efficient but now, B and on FTAs, if pursued, must be combined with strengthening
C sign an FTA and now mangoes from C are imported at zero Indias ability to respond with WTO-consistent measures
tariff. Consider this such as anti-dumping and conventional duties and safeguard
measures.
Now C has become more competitive and trade will get diverted
from D to C, thats another side effect of FTAs.

Impact of FTAs on Indias trade

The overall effect on trade of FTA is positive and statistically
significant
With ASEAN, trade has resulted in more imports than
exports, this widening our trade deficit
Impact of FTAs on different industry segments fall differ-
ently <its only to be expected>

33
Reforming The
Fertiliser Sector
Before reading this chapter, its important that you read Chapter amount of per kg subsidy to all manufacturers, if production cost
three spreading JAM, chapter two exit problem/ chakravyuha is less, you can sell it lower prices and capture market. It incen-
challenge and fundamentals of subsidy. tivises inefficiency this way.

Fertilizer accounts for large fiscal subsidies (0.73 lakh crore or Contrast this with urea subsidy which is cost plus based . In this
0.5 %of GDP), the second-highest after food. regime govt fixes price of urea. Suppose govt fixed urea price at
Only 17,500 crores or 35 per cent of total fertilizer subsides 500 rs per kg. Firm A produced 1 kg urea at 700, govt will give it
reaches small farmers 200 rs (700-500) so that it could sell it at 500. If more efficient
firm B produced 1 kg of Urea at 600 rs, it will get 100 rs subsidy
(600-500). Clearly, theres no incentive to be efficient. More inef-
Where does the rest (65%) of ficient you are, more subsidy you get.

subsidy amount go? Other benefits of nutrient based subsidy

Obviously it leaks out to black market, large framers (bounty for Note that in cost plus method, govt can only subsidize a few
the well off ) and inefficient producers (exit problem). fertilizers. But in NBS, govt has to simply state, it will give
100 rs per kg for N, K, P, Boron, Sulfur, Zinc etc. It will thus
We will come to the question of leakages later but before that let encourage production of complex fertilizers <many nutrient
us know a few basics about fertilizer sector and its regulation including micro nutrients in the one fertilizer>
in India. Complex and micro nutrients will increase the productivity
of soil.
There are 3 basic types of fertilizer usedUrea, Diammo- It will encourage greater competition , leading to produc-
nium Phosphate (DAP), and Muriate of Potash (MOP) i.e tivity gains.
N,P,K fertilizers.
Urea dominates the sector. It is the most produced (86%),
the most consumed (74%) and the most imported (52%). Now lets discuss 5 kind of govt
Urea also faces the most government intervention <50%
under movement control compared to 20% for other two intervention in urea sector
fertilizers,>
Urea also receives maximum subsidy (70% of total fertilizer Controlled maximum retail price <encourages diversion
subsidy) as well as in per unit terms (75% of cost of urea is and black marketing>
subsidized compared to 35% for other two) Firm specific cost plus subsidy <inefficient firms get larger
Urea is also not included in nutrient based subsidy regime subsidies>
Consignment specific subsidy to importers
Canalization of imports Only 3 agencies allowed to import
Nutrient based subsidy <shortages when domestic production falls>
Movement control <govt tells how much to import and
Under this method, subsidy is given on the basis of nutrient con- where to sell>
tent in the fertilizer. Suppose govt decided it would give 100 rs
subsidy per kg of potash. Now, if cost of a fertilizer which contains All these controls result in leakages. As we saw earlier only 35%
1 kg of potash is 1000 rs, govt will give 100 rs and he would be able of subsidy reaches small and marginal farmers.
to sell it at 900 rs. <govt does not fix retail price, govt gives same

34
 Black marketing Simply because the principle of one prod-
uct one price (we discussed it w.r.t. LPG earlier) is violated. 3. Subsidy to inefficient firms result of cost plus regime which
Urea is only subsidized for agricultural uses but it is used does not encourage efficiency gains.
for industrial purpose also < one of the ingredients in chem-
ical industry, explosives, automobile systems, laboratories, Result even though urea consumption has increased steadily
medical uses, flavour enhancing additive in cigarettes and over the last 15 years, no new domestic production capacity has
others>. As we know cost of subsidised urea is 75% lower been added, leading to a large dependence on imports. Efficient
than cost of non subsidised urea which gives strong incen- firms are forced to shut their shops.
tive to divert it to the black market. Why?

Simple- Suppose urea for agri use is 250 rs and for industrial use Externalities of urea prices
is 1000 rs, theres strong incentive to sell it to industrial consum-
ers at 750 rs and show it as urea for agri use. What is externality?
Similarly, urea is diverted to Bdesh, Nepal where urea prices are
high. an externality is the cost or benefit that affects a party who did not
Result- Shortage of urea in domestic market. choose to incur that cost or benefit <for instance, vehicle owners
pollute the environment, we all suffer the consequences an exam-
Who suffers small and marginal farmers. Rich farmers are well ple of negative externality. Can you give us an example of positive
connected and get subsidies urea while small farmers have to buy externality in comments plz>
urea from black market at much higher price <51% of farmers buy
urea at above M.R.P.> Its clear urea is under priced compared to other fertilizers
resulting in excessive usages.
In the three eastern states bordering Bangladesh, 100 per cent Ideal N:P:K ratio for Indian soil is 4:2:1 but actual ratio is
of farmers had to buy urea at above MRP in the black market 8.2:3.2:1 i.e excessive usage of urea
<diversion to Bdesh>
Black market effects are aggravated by a further regulation Result-
canalisation. As we saw , only three firms are allowed to import Deterioration of soil quality
urea into India, and they are also instructed when to import, what Fertilizer leaching to water bodies resulting in pollution of
quantities to import, and in which districts to sell their goods. water
And we all know how good govt is in forecasting needs. Algal Bloom

Result- Shortages and shooting up of urea prices when demand Reforms- aim of reform is to eliminate leakages while benefiting
is at its peak and invariably small farmers suffer disproportion- small farmers
ately.
decanalising urea importswhich would increase the
Reform by govt.-neem-coating urea number of importers and allow greater freedom in import
decisionwould allow fertiliser supply to respond flexibly
Neem-coating makes it more difficult for black marketers and quickly to changes in demand
to divert urea to industrial consumers. bringing urea under the Nutrient Based Subsidy program
Neem-coating also benefits farmers by reducing nitrogen
losses from the soil by providing greater nutrient to the crop
<less urea required> Turning fertiliser into JAM
Work as pesticide
Less water pollution Fertilizer subsidy is an ideal case for JAMming (Chapter three)
as leakages are high and central govt controls fund flows.
2. Benefits large farmers A regressive subsidy. As we saw small
farmers suffer due to black marketing while large well connected Also, urea manufacturing is not labour intensive so no harm to
farmers take advantage of subsidies. workers.

35
Ideally fertiliser subsidies would be targeted only at small and As urea is more sensitive, it could be initiated first for other
marginal farmers. But there are problems with targeting fetilizers

Assessing povertybased on landholdings or some other Other reforms-

measurewill be difficult
How to target tenant farmers and sharecroppers <10% of all Rationalise subsidies to domestic firms <shifting to NBS
farmers are such farmers and they should not be excluded regime> which would release fiscal funds to spend more
in any case> effectively on schemes that help poor farmers, such as drip
Relatively low levels of last-mile financial inclusion in much irrigation and connectivity through the Pradhan Mantri
of rural India <last mile challenge, chapter three> Gram Sadak Yojana
Secure long term fertiliser supplies from locations where
What can be done if not JAM? energy prices are cheap
Encourage Indian firms to locate plants in countries such as
Set a cap on the number of subsidised bags each household can Iran following the example of the Fertiliser Ministrys joint
purchase <just like 12 subsidized LPG cylinders> and require venture in Oman, which allowed India to import fertiliser
biometric authentication at the point of sale (POS) <BAPU (chap- at prices almost 50 per cent cheaper.
ter three)>

Requiring biometric authentication would make it harder

to conduct large-scale diversion
Imposing a cap on the total number of subsidised bags each
farmer can purchase would improve targeting <Small farm-
ers would still be able to get all their urea at subsidised prices
but large farmers may have to pay market prices for some
of the urea they buy>

36
37
Structural
Changes in
Indias labour
markets
India is midway through its demographic dividend <what is ing 28 million were informal workers in the formal sector. <You
demographic dividend? Answer in comments>. To exploit this can do the math of percentages>
dividend Indias economy needs to do three things-
For detailed information regarding, formal/ informal click here
Movement of workers from agriculture to industry <pull
factor of higher income in industry not push factor of dis- Lets come back to main topic
tress in agriculture>
Shift of workers from informal to formal sector < good Of the 10.5 million new manufacturing jobs created between 1989
jobs jobs that are safe and pay well, and encourage firms and 2010, only 3.7 million (35%) were in the formal sector i.e.
and workers to improve skills and productivity> informal firms account for most employment growth, thats why
Rapid urbanization <it will automatically follow industri- the need to promote entrepreneurship.
alization> But informal sector jobs are much worse than formal sector jobs
Note 1- there is lot of confusion b/w informal and unorganized as-
sector. For the sake of simplicity, sectors not covered under fac-
tory act, 1948 (<10 workers with power, <20 without power) is Wages are, on average, more than 20 times higher in the
unorganized sector. Informal sector is virtually synonymous formal sector.
with it. Formal sector jobs also score better on some non-pecuniary
grounds. For example, they allow workers to build employ-
Note 2- Formal jobs are jobs with some social security i.e insur- ment history which is important for gaining access to
ance, pension, provident fund etc. Formal jobs would be there in cheaper formal credit, getting better jobs in other enter-
organized or formal sector only but in formal sector, there can prises.
be informal jobs i.e contract workers not provided with social Social security
security. Thus the challenge of creating good jobs in India could be
seen as the challenge of creating more formal sector jobs,
Note 3- NCEUS estimated in 2005 that out of total 470 million which also guarantees worker protection.
workers, there were 423 million informal workers in India of
which 395 million belonged to the informal sector. The remain- But why have formal sector jobs not increased? Also why has

38
informalization < hiring of contract workers >increased even in to reform labour laws. <But how can states enact laws repugnant
formal sector jobs. to central laws? Answer in comments>
One of the reason is complex maze of labour laws which raise
compliance costs as firms hire more workers forcing them to stay So Rajasthan govt has amended various labour laws <Quote these
small. Needless to say, employers have started to get around them in mains answer or essay>
and one of the strategy is use of contract labour which is lead-
ing to informalisation of formal sector. Also in the absence of Industrial Disputes Act government permission will not
reforms by parliament, states have taken upon themselves the be required for retrenchment of up to 300 workers <only
task of reforming labour laws. You can read more abut need for 100 workers in central act>
reforming labour laws in this story, labour reforms in India Trade Unions act- increased the percentage of workers
needed for registration as a representative union from 15 per
cent to 30 per cent<necessary as trade unions have become
Contract Labour highly politicized>
Contract Labour Act -the amendments raise the applica-
It provides two key benefits: bility of the Act to companies with more than 50 workers
from the current 20
The firm essentially subcontracts the work of following Factories Act currently applicable to premises with more
regulations and managing inspectors to the contract labour than 10 workers with power and 20 without power, the
firm amendments raise these numbers to 20 and 40, respectively
Because contract workers are the employees of the contrac-
tor and are not considered workmen in the firm, the firm Good labour reforms should simultaneously increase social secu-
stays small enough to be exempt from some labour law (<10 rity and worker protection <unemployment allowance, reskilling
employees not under factory act, <100 employees not under of workers, pension, insurance etc> but Rajasthan govt has not
industrial dispute act> any step in that direction in labour reforms.
For these reasons, contract workers increased from 12% of all
registered manufacturing workers (formal sector workers) in There may be a possibility of competitive federalism becoming
1999 to over 25 per cent in 2010. too competitive, inducing a race to the bottom with states pushed
into giving too many concessions. But India seems far from such
But this strategy is not without costs a situation. For example, changes that certain states are consider-
ingsuch as Haryanas proposed online filing of returns through
Hiring workers through a contractor can be more expensive a single form covering 12 separate labour laws and e-maintenance
Contract workers do not feel as much loyalty to the company of all labour-related recordswould likely improve compliance
as regular workers would, reducing employers incentive to and worker welfare
invest in their training <low skilled workers, low produc- Labour reforms help in entry of large firms <as compliance cost
tivity> decreases, there is no incentive to remain small or any disin-
Worker protection and worker rights go down the drain centive to hire more workers> and the benefits of the entry of
Hiring contract workers today hurts a firms productivity a large manufacturing company to a state can go beyond scale,
tomorrow, precisely because contract workers do not accu- depending on the kind of products they manufacture. How ans
mulate firm specific human capital. Why-

What you export matters because exporting develops a

Competitive federalism countrys local know-how and supply chain networks, bring-
ing it closer to the global frontier for the exported good <best
As labour comes under concurrent list <lists come under which product available in world market>
schedule of constitution? Whats the procedure for amending the Skills may be more transferable across certain industries
various lists? Answer in comments>, states have taken initiatives than others. For example, it may be easier to make carsa

39
 complex productonce a country has developed expertise
in making bicyclesa simpler but related product. It spreads economic development to underdeveloped areas
In this sense, what a country manufactures today matters Reduces spatial mismatch in the labour market <workers can
not just because it affects employment and growth today, work near their homes>
but also because it shapes the set of products a country can Improve competitiveness by raising firms access to lower cost
profitably produce tomorrow labour <low cost of living in smaller towns>
For instance when China first entered the mobile phone It improves female labour force participation, more earning,
assembly space, it was producing only electrical connectors financial security for women, women empowerment but? How
and cables; now it is producing sophisticated, high growth <very very important>
and high valued-added products such as smartphones and
tablets. Most explanations of low labour force participation in India
Lesson is that we should promote entry of manufactures which focus on supply side factors like cultural norms that frown
help develop know how which can be transferred across sectors on women working outside the home
to move to manufacturing high value addition goods with mobile Less attention has been given to demand-side explana-
phone manufacturing being a good example. tions, which essentially emphasise that a key determinant
of female labour force participation (LFP) is the availability
of suitable jobs <flexible jobs near their homes>
Relocation It is a striking fact that the areas in India that have seen the
greatest decline in female labour force participation in the
Apart from the complex maze of labour regulations, there are last decade are those villages that have rapidly urbanised
some other factors which prevented development of labour and are now part of towns and small cities.
intensive manufacturing in India Farming jobs in these areas are no longer available, but
women-friendly service sector jobs are yet to take their place
High cost of living in metros <it increases labour cost> From this perspective, female LFP can be expected to
High transport and logistics costs and weak connectivity depend on the availability of suitable jobs, which are flexi-
from suburbs to metro <good connectivity and low cost ble and located close to home located in small cities, utilizing
transport would allow workers to commute to work to womens comparative advantage in garments, flexible work-
metros> ing hours and childcare on site
Low female labour force participation rate <suitable jobs
not available near their homes> Till know we say how firms are getting around the problem and
For instance apparel industry is highly labour intensive, how states are reforming labour laws but what should be the
with 30% of costs from wages. Only 2-3% of costs are due to centres role?
capital-intensive inputs like power. And yet India is ceding
market share in the global apparel industry to countries like It should be to ensure worker centric labour regulations by
Bangladesh and Vietnam. expanding workers choice and reducing mandatory taxes on
formal sector employment.
Formal sector apparel firms are about 15 times more productive Lets understand this with the example of epf
than informal sector yet Indias apparel sector is dominated by
informal firms while in China there are large apparel firms and
now other countries are taking over. What is EPF?
To get around this some firms are now reloacting to smaller town Employees provident fund is a scheme under which its manda-
and rural areas and it has several benefits for economy- tory for workers (organized private sector workers) earning less
than 15k to deposit 12% of their income in EPF account. Employ-

40
ers contribute equivalent amount. EPFO invests it in mainly govt Various surveys have suggested workers would rather like
securities and they get annual interest rate based on return. They cash in hand as majority of them are liquidity constrained
get principal plus interest at retirement thus it is meant to pro- Further its difficult to access the account.
vide lump sum benefits to workers at the time of retirement. Though govt has taken some initiative to make it easier for
them to access the account. For instance, uniform single
Higher income individuals are not mandated to deposit any account number portable across jobs and locations, e-fil-
amount but they still do to take advantage of EEE provision. Read ing and e-withdrawal etc, survey suggests giving workers
more about this provision and subsidy for rich in this economic the choice to get cash, remain in epf or move to NPS while

survey chapter keeping employers contribution intact.

Giving choice is important as EPF has high administrative
Lets analyse impact of EPF on workers- costs. The EPFO requires that employers pay an admin-
istrative charge of 0.85% of the workers salary. This may
From workers choice perspective, they are being forced to not seem large, but it amounts to service charges of 3.54%
deposit significant proportion of salary in EPF (12% when (=0.85/24) which are higher than the rates of most private
they already earn so little) mutual funds. Competition will help bring down adminis-
They dont get any tax advantage either (already outside tax trative cost.
bracket)

41
Govt sought to reform EPF but buckled under pressure and rolled
back all three reforms

Three EPF fliplops

1. Tax on withdraw- At present epf is EEE. Proposal entailed
taxing 60% of withdrawals and if that 60% is used to buy annuity
it would be tax free i.e 40% of withdrawal tax free, tax on 60% if
no annuity is bought

What is annuity-

It is a form of insurance or investment entitling the investor to

a series of annual sums. Basically if you have 1000 rs and you
buy annuity, pension fund manager will invest it in bonds and
equities and you will get some amount every year based on your
initial corpus and return on investment

Talking about annuity, why dont you revise the hybrid annuity
model of PPP project here

Objectives

Idea was to make EPF equivalent to NPS which earlier was

an EET scheme. Subsequently 40% was made tax free and
remaining 60% would be tax free if used to buy annuity.
Ultimate aim was to make India a pensioned society. As
lump sum withdrawals are often used immediately, theres 3. Reducing interest rate on EPF to 8.7% from 8.8%-
nothing left for rest of the life. Learn about social security
schemes in India here Objective-
Protest Of course salaried class wouldnt like this idea. Govern-
ment has no business deciding for them what they do with their Aligning them with market determined interest rates. If all inter-
money plus taxation is big no. est rates are falling and return on govt securities also falling as
inflation comes down, theres no reason for epf interest rate to
2. Restrictions on premature withdrawal -It was announced that not fall
workers will not be able to withdraw employer share till 58 years As in future even inactive accounts will get interest benefits,
of age. At present, they can empty entire corpus if they remain future surplus would fall and future rates would come down dras-
unemployed for two months or at 54 years of age. tically, so start cutting rates now <at present accounts which show
no activity for three years dont get any interest>
Objective Idea was to prevent premature withdrawals so that Protest- that EPFO had generated enough return to warrant high
something is left for the old age interest rates

Protest It;s our money. you govt dont tell us what to do. Further, What I dont understand is how EPFO generate such a high rate of
often times we dont have any job after 50 years of age. How would return when it invests almost entire corpus (95%) in govt securi-
we survive for eight years without EPF money. ties and if everything is to be invested in govt securities, whats the
need of an organization called EPFO? <Ye mere man ki baat hai>

42
Before we end this chapter, lets learn in brief about National
Pension Scheme (NPS)

It is a pension scheme <defined contribution scheme i.e.

employees contribute while they earn and get pension
according to corpus accumulated during the working years>
which is mandatory for govt workers (except armed forces)
who joined the service after 1st july 2004. <Earlier there was
defined benefit scheme in which pension amount was fixed
based on years of service
Employees deposit 10% of their salary which matching
amount by govt.
Even private sector workers can choose to invest in NPS vol-
untarily (unorganized sector workers not covered under
EPF) <EPF is compulsory and only salaried employees
under organized sector can invest in EPF>
Minimum investment towards NPS is 6000 rs per year
With NPS, people have the flexibility to choose between dif-
ferent asset classes to invest in equity, corporate bonds
and government securities <In EPF >90% investment in
govt securities while NPS is allowed to invest up to 50% in
equities>
As people get to take some exposure with equity, they can
earn higher returns over the long term <flip side is that there
is no assured return in NPS while there is assured return
on EPF>
The Pension Fund Regulatory and Development Authori-
ty(PFRDA), an agency under the administrative control of
the Finance Ministry is the regulator

43
Powering
One India

44
Power or electricity is very essential constituent of infrastructure What are the other issues in Indias
affecting economic growth and welfare of the country. India is
the 5th largest producer of electricity in the world. At an elec- power sector?
tricity-GDP elasticity ratio of 0.8 <for 1% increase in GDP, 0.8%
increase in electricity generation required>, electricity will con- A- Complexity of tariff schedules
tinue to remain a key input for Indias economic growth.
There are separate tariffs for poultry farms, pisciculture,
Uninterrupted, reliable power at reasonable cost is essential wetland farms (above and below a certain size), mushroom
for the success of make in India which in turn is critical for the and rabbit farms, etc <complexity of tariff structure>
transformation of industrial sector which would provide jobs to It prevents economic actors from responding sufficiently
burgeoning young population entering the labour force every to price signals due to the high cost of processing the price
month <1m new entrants to labour force every month>. information <if its so complex, our mind can not take eco-
nomically rational decisions>
High tariffs and erratic supply for industry have led to a slow but Suggestion Simplification of tariffs with, perhaps no more than
steady decline in the growth of industrial electricity purchases 2-3 tariff categories <say low tariff below certain level of power
from utilities and a gradual transition towards captive generation consumption, high after that level and separate category for
often using diesel gen sets which is more expensive as also more industrial tariff>
damaging to the environment.
It will improve transparency and may well yield consumption and
collection efficiency, along with governance benefits <consumers
Status of diesel gensets in India- will be able to take rational decisions, no scope for rent seeking>

47% of firms report using a diesel generator B- Tariffs And Cost-

Total capacity of the diesel generators (DG) in the country
may be as high as 72 GW and growing at the rate of 5 GW Cmmon sense suggests avg tariff (AT) should not be less than avg
per year cost of supply (ACS) but in India-
DG capacity for industrial loads greater than 1 MW is 14 GW
A substantial portion of the rest (58 GW) may be contrib- Average tariffs in some cases are set below the average cost
uted by micro and small industries, with load capacities of of supplying electricity
less than 1 MW Even after adjusting ACS for Aggregate Technical and
Commercial (AT&C) losses AT continues to stay below the
Effect of captive power generation using diesel gen sets adjusted level of ACS in most states i.e tariff are set way
below the required level <what are AT&C losses? Answer
This particularly affects SMEs as they are unable to shift to in comments>
captive power generation and when they do, they are unable Suggestion- -Tariffs reflecting costs are a necessary condition for
to absorb the higher costs as their margins are generally very discoms to sustain themselves over the long-run. So avg tariffs
low. need to be raised while giving relief to poorer section of society.
Agro based and other industries are not able to develop in How?
peri urban or rural areas and rural population either remain
stuck in unremunerative agriculture or migrates to urban Exploiting Progressivity to Lower Tariffs for the poor
areas in search of jobs (distress migration)
It affects competitiveness of our industry and our exports There is, at present, no specific policy guidelines on the intra-cat-
suffer egory cross subsidisation or subsidy provisioning
Pollution, environmental degradation, climate change, The tariff schedule is progressive as the consumption
global warming increases, although, Avg billing rates (ABR) for all the con-

45
46
 sumption categories lies below the average cost of supply
(ACS) implying that costs are not fully recovered even from
high end consumers i.e state or industry subsidizing con-
sumption of rich
Other countries such as Bangladesh, Sri Lanka, South Korea,
Vietnam and Brazil better exploit the progressivity of elec-
tricity tariffs in the domestic category <higher ratio of tariffs
charged to the rich relative to poor>
Suggestion- make tariff schedule after welfare analysis and
charge consumers progressively much more for higher consump-
tion while simplifying tariff schedule

Advantage- cross-subsidisation occurs within the residential

consumers itself< rich and consumers with high consumption
intensity within the residential sectors subsidise prices for con-
sumers with lower consumption>
Barriers to open access-
Given their relatively inelastic price elasticity, rich consumers
will continue to maintain their consumption even after price Price barriers- cross subsidy surcharge Industrial consumers
increase. The net effect is that the residential revenue collection procuring power from discoms subsidize residential consumers
becomes cost neutral for the discoms (loss making at present) but they dont have to do so if they procure power through open
access, electricity regulator levies a surcharge to cover the cost of
residential subsidy known as cross subsidy surcharge.
What has govt done so far?
Idea was that cross-subsidy surcharge to be levied on OA con-
Open access policy and its present status sumers would come down over time. Nonetheless, cross-subsidy
surcharges over the years have gone up as discoms lobby hard to
What is open access simple- open to access electricity from increase surcharge.
any seller i.e. consumers being able to purchase directly from
power producers rather than distribution companies. Non price barriers- delay in granting open access, transmission
constraints and congestion and transmission losses
Advantage- As it allows generators to sell power to the highest
bidders while consumers can source their needs from the most In short price and non-price barriers come in the way of sin-
economic seller, it promotes competition and efficiency gle-nationwide electricity prices through open access

Open Access (OA) policy introduced under Electricity Act

2003, allows consumers with electricity load above 1 MW to Some achievements
procure electricity directly from electricity markets
highest ever increase in generation capacity <in 2014-15 the
OA provides an aggregation of the country-wide supply and addition to plant capacity in utilities was 26.5 GW, much
demand on the same platform. Therefore, this constitutes a first higher than the average annual addition of around 19 GW
step towards discovering a single market price for power around over last five years>
the country <if anyone can buy and sell from anybody freely it bringing down the peak electricity deficit in the country to
would ultimately create a single price for electricity and thus one the lowest ever level of 2.4%
market for power> Indian Railways (IR) attempting to shift to open access (OA)
for power purchase

47
 From power deficit to power surplus <its possible because Metering of distribution transformers /feeders / consumers
discoms are so much under debt that they just dont want to in urban areas.
purchase any more power, all the more important to expe- IT enablement of distribution sector and strengthening of
dite the shift to open access> distribution network.
Grid parity for solar generation is on its way to becoming D. Domestic Efficient Lighting Program (DELP)
a reality <tariffs reached an all-time low of R4.34/kWh in
latest auction> <Whats grid parity? Why is it important? 77 crore LED bulbs to replace household and street light incan-
Answer in comments>/ descent bulbs

E. National Tariff Policy, 2016

Some policy decisions of govt of
Cross subsidy surcharge formula revised.
India- Regulator will devise power supply trajectory to ensure
24X7 power supply for all consumers latest by 2021-22 or
A- Ujwal DISCOM Assurance Yojana (UDAY) earlier

States shall take over 75 per cent of discom debt outstanding Installed capacity in India as of 31st march 2016 (ratta laga lo)
as of September 2015.
Reduction of Aggregate Technical & Commercial (AT&C) Thermal 210 GW (185 Coal)
losses to 15 per cent by 2018-19. Renewable 85 GW ( 43 Hydro plus 42 others)
Reduction in difference between average cost of supply and Nuclear 5780 MW
average revenue realized (ARR) by 2018-19. Total 301 GW
Increased supply of domestic coal to substitute for imported
coal. Break up of renewable energy
States shall take over future losses of discoms in a phased
manner. Wind- 27 GW
Banks/FIs not to advance short term debt to discoms for Solar- 6.7GW
financing losses.

B. Deen Dayal Upadhyaya Gram Jyoti Yojana (DDUGJY)

Electrification of all villages <how many villages are unelec-

trified? what is criteris for calling a village electrified?
Answer in comments. >
Metering of unmetered connections for reducing losses.
Separation of feeders to ensure sufficient electricity to agri-
culture and continuous supply to other categories.
Improvement of sub-transmission and distribution network
to improve the quality and reliability of supply.

C. Integrated Power Development Scheme (IPDS)

Strengthening of sub-transmission and distribution net-

work in urban areas.

48
 Biomass and bagasse cogeneration -4.8GW <what is cogen- Electricity amendment bill 2014
eration?>
Small hydel- 4.3 GW The Bill amends the Electricity Act, 2003.
Total- 43GW It seeks to segregate the distribution network business
and the electricity supply business, and introduce multiple
Renewable energy target by 2022 supply licensees in the market i.e separation of content and
carriage<distribution network will now become like wires
100 GW solar power, which anybody would be able to access just as we can obtain
60 GW wind energy telecom services from any service provider, we would be able
10 GW small hydro power, to get electricity from any provider>
5 GW biomass-based power The Bill introduces a supply licensee who will supply elec-
The target for solar is split into 40 GW Rooftop and 60 GW tricity to consumers.
through Large and Medium Scale Grid Connected Solar The distribution licensee will maintain the distribution
Power Project network <like present discoms> and enable the supply of
electricity for the supply licensee.
Nuclear energy target

Earlier the target was 63,000 Mwe by 2032 but now govt seems
to have slashed it to just about 14,500 Mwe by 2024 as India-USA
nuclear deal seems to be floundering (for more refer this link)

49