'Public Finances and the Plan', note prepared for the Kerala State Planning Board, August 2011.

Public finances and the Plan

Note prepared for the Kerala State Planning Board

 

Pulapre Balakrishnan

 

An issue that may be considered for inclusion in the Approach Paper is the ‘financing’ of the Plan. It can be too easily assumed that public-private partnership (PPP) will take care of this. However, I believe that at the present juncture in Kerala, even allowing for the centrally-sponsored schemes that remain to be tapped, a substantial part of the outlay would have to come from the State government. At least, this would hold for the early stages of the 12th Plan.

            In macroeconomic terms an increase in the rate of growth of the economy would require greater investment outlay. At first glance and in the short run, this should be focused on physical infrastructure. Roads, ports, city centres and arrangements for solid- waste management come to mind. Historically, across the world, investment in these areas has come in the form of public investment, though, in marked difference from India, also from local government. I shall return to the last point. A sizeable step-up of public investment in Kerala would require an improvement in the public finances. Currently, an overwhelming share of the expenditure is on salaries and pensions, leaving very little for capital formation. Unless this is broken the government’s capacity to invest and to thus influence the rate of growth of the economy is seriously compromised.

            Any strengthening of the fiscal capacity of the state can come about only via greater resource mobilisation. The importance of strengthening the fiscal capacity of the  state via resource mobilisation is insufficiently recognised. In order to bring this about, only two options exist for the state, to raise taxes and user fees and by increasing the surplus of the public enterprises. In general, public expenditure on private entitlements must be matched by public revenues, otherwise we would be incurring debt to finance consumption. This may well be the case currently in Kerala. If it is indeed so, public saving must increase by that much more to leave something over to investment even after consumption expenditure has been matched by increased public revenues.

            A White Paper on the State’s finances has been released in July. This was indeed timely. However, this transparency must now be matched by an effort to restructure the public finances with the aim of raising the level of public investment. There are three considerations that arise. First, as I have stated already, there must be a thrust towards greater resource mobilisation. Secondly, fiscal correction that erases the fiscal deficit (or even the revenue deficit) does not constitute resource mobilisation. To see this, note that the deficit can be zero at very low levels of public investment. In the present context in Kerala, this would be a lazy approach to managing the economy as it overlooks the need to mobilise resources for investment. Finally, despite the high level of debt, if public investment is to be increased a short–term increase in debt may have to be countenanced as it is not always possible to improve the public finances immediately, even though every effort should be made to do so at the earliest. Therefore, in the short-run the government may have to borrow, thus increasing the level of debt. Where this increase in borrowing goes into productive expenditure that yields government revenues in the future, there is no need to fear this. But the initiative to borrow must be preceded by a policy announcement that the government is committed to a long-term strategy of lowering public debt via taxation , other forms of resource mobilisation  and the expectation that public bodies will yield greater saving that they have done in the recent history of  Kerala.

            When taking a view on the role of the public finances in promoting growth and development in Kerala it may be useful to scan the international experience. This experience has lessons for us in 3 spheres, namely, the level of public expenditure, the desirability of fiscal deficits and the role of local governments. I briefly look at each of  these in turn. There appears to be no reason to believe that any particular level of public expenditure should be adhered to. The economies of western Europe, including the most successful, such as Germany, have quite high levels of public expenditure. But then they also have high public revenues. We thus return to my argument that welfare ought not to be financed by debt. For Kerala this points to the need for greater resource mobilisation. Coming next to the desirability of fiscal deficits, we need to guard against the idea that a deficit is always and everywhere serving a public purpose. The recent example of the United States speaks against the practice of running uncontrolled deficits open-endedly. Finally, we need to rethink how local bodies fit-in with the plan. The political decentralisation in Kerala, which has received much attention, has not been adequately matched with fiscal decentralisation. Local bodies must have greater powers to raise revenues and be encouraged to use these powers. Where the revenues of these bodies are dependent upon economic activity they would have an incentive to actually promote growth and development. At present, the responsibility of local bodies for economic activity, and thus the relationship of the local bodies to the Plan, is not clearly defined. Decentralisation has been seen as a route to disbursement of funds from a central kitty, not as a means to promote economic activity. Academic research on China has demonstrated that local government bodies there, endowed with fiscal powers and charged with accountability for economic activity, have been one element in its recent history of rapid growth. By comparison, the strategy in India may have relied excessively on a top-down approach. A measured view would be that we need to strike a balance. In any credible plan for raising the rate of growth of Kerala’s economy the local bodies would have a role.