Reshape spending, at the Centre and in states

It should concern us that only about a fifth of public expenditure goes towards capital spending and the social sector. This needs reconfiguration

Modern monetary theory, which has garnered some support among United States (US) politicians, brings a new perspective on the relation between money and the government. Its principal proposition is that governments that issue their own money can’t go broke, for they have the power to issue more. Its adherents go on to argue that the role of taxation is not to enhance the spending power of governments, for they can always issue money, but to enforce acceptance of the government’s paper as legal tender. This is because taxes must be paid in legal tender, and not in any other medium. While this is an interesting perspective, it does not have a view on why governments spend at all.

                Public spending is very large in the most successful economies of the world, namely in Europe and the US. It may be justified on the grounds that we need public goods to make us more productive and to have a better life. Roads and bridges would fall in the first category and parks and sanitation in the second. These goods are termed “public” for they are accessible to all. Now, precisely because access to them cannot be denied, they are unlikely to be provided by the private sector.

                In addition to public goods, there are some private goods which attract public expenditure as they give rise to positive externalities, or favourable spillovers for the social good. Health and education are examples of such goods. Think of educated individuals enhancing the productivity of those with less education or healthier individuals reducing the possibility of transmission of communicable diseases. For these reasons, governments tend to provide health and education, even though they are not strictly public goods. I shall refer to health and education as the social sector of the economy.

               With this understanding of public expenditure, turn to the situation in India. Studying the expenditure pattern of the Government of India, we find that for close to a decade now, its combined spend on capital goods and the social sector has hovered around 20%. It is remarkable that this has been a practice common to both the United Progressive Alliance and National Democratic Alliance governments, suggesting that, in an important area of economic policy, there has been little difference between these two ostensibly rival political formations. Now, it should be a matter of concern to us that only about a fifth of public expenditure goes towards capital spending and the social sector. This needs reconfiguration, with the allocation tilted towards these sectors, away from subsidies and public administration among other items.

                Since 2003, the fiscal, nay economic, policy of the central government has been guided by the Fiscal Responsibility and Budgetary Management Act. This has involved focusing on the volume of spending, with the requirement that the fiscal deficit be taken towards the figure of 3% of Gross Domestic Product (GDP). It is not just that this figure is arbitrary, perhaps borrowed from the figure adopted by the European Union for its member countries, the trouble is that with our eyes riveted on the fiscal deficit, we lose sight of where public expenditure is going. Indeed, we had not given enough thought to the question of expenditure on health till the Covid-19 pandemic erupted, exposing our total unpreparedness, particularly in terms of health infrastructure.

                When on the question of public expenditure on health, our focus shifts to the states of India, for health is a state subject and there are startling results. While the composition of public expenditure of the states has received little attention at the national level, it is perhaps more crucial than the Centre’s public expenditure as it has greater impact on our everyday life. The average share of health expenditure in the total budgetary spending of the states was barely 5% in 2018-19. This was a slightly higher share than that of the Centre in that year but not much more, and nowhere near what it should be given both the importance of health and that it is a state subject. While there is no clear definition of what the right level of expenditure on health should be, we have good reason to believe that the states have neglected it in their budgetary allocation for decades. How do we know this? There is a substantial variation in the mortality from Covid-19 across the states of India. Sreenath Namboodhiry and I have shown that mortality is inversely related to public expenditure on health as a share of the State Domestic Product. In addition, we found to our surprise that there is an inverse relation between this measure and state per capita income. That is, the richer states of India have chosen to spend less in relation to their capacity than the poorer states, with deadly consequences.

                In the season of budget presentations, with the economy reeling under the impact of Covid-19, we will, of course, expect the Centre to step up its expenditure. However, states must play a significant role too. They could start by reconfiguring public expenditure to strengthen their social sectors.