Pranab-da, what we need is to get the govt off our backs

By Shanmuganathan Nagasundaram

Pranab_da_ should be a much stressed man these days. Multiple problems - escalating consumer prices, mounting deficits, declining currency, and falling investment trends - have surfaced and he has very few levers at his disposal to deal with them.

In as much as he would like us to believe that the constraints are out of his sphere of influence, the salvation, as is usually the case, lies within. The FM needs serious introspection to understand the flawed economic thinking that has led to the above problems.

While the economic ideology of the UPA is terribly flawed, as I have explained earlier (See: Saving India from the Keynesians), this is probably a good time to review the outcomes of these ideologies (with quotes from a recent speech by our FM, **_see below_** ) and see how these policies are taking India further away from the correct approach.

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One such assertion is that there is a $1 trillion demand for infrastructure investments in India, and that there is huge scope for private players to take up this opportunity and help the economy grow.

To be fair, the statements below broadly reflect the thinking of the UPA government and are not restricted to Pranab Mukherjee alone. But since he is the FM and is verbalising these policies, he happens to be at the receiving end of this commentary. With that caveat, let me explore the fallacies behind the thinking in greater detail and in these flawed ideologies. I have also stated the Misesian perspective that would point out the correct direction of economic ideology.

Assertion 1: India has a “demand” of $1 trillion

I don’t know the particular mechanism that enabled the Planning Commission, or whosoever came up with this number, to be specific about this magical $1 trillion,. But I am sure they have not considered even the basic requirements of 24x7 electricity, water and road connectivity for the entire population. There is no reason why Indians should not “demand” these facilities that are taken for granted in the developed economies. So it’s really not a question of demand being limited to some number as this “$1 trillion” implies.

The real issue is that of the supply of capital that can provide these goods. And if the government continues to demonise corporates in the form of regulations and carries with it the government-knows-best attitude towards law making, then the only capital that will flow towards industrialisation would be that from crony capitalists (the types that dominate higher education and upstart mining barons).

The Mises Institute (Austrian School) Perspective: Economics is about how we satisfy our unlimited wants with our limited resources. So create conditions that would allow the flow of capital towards satisfying these demands without the burden of government regulations and permissions.

Assertion 2: The Indian government would provide about 50 percent of the above required capital.

Capital formation happens when a corporation or an individual provides a good or service in a free market for more than what it costs to produce. This difference (i.e. profit) is what is available to corporations as capital to invest in business expansions. The government is, quite frankly, incapable of doing the above without regulations and sovereign moats favouring them. So the only way a government can raise capital is taxation (or inflation, which anyway is a form of taxation)

So what the government does when it makes 50 percent of the “required funds” available for investment is to take capital away from efficient entrepreneurs/businesses and hands them over to less efficient entrepreneurs or to crony capitalists in the form of various subsidies, low-cost loans and public-private partnerships. Wouldn’t our country be better served by allowing these entrepreneurs to retain this capital to enable them to invest in the opportunities they deem best? After all, it seems a no-brainer that individuals who are good at capital allocation, by definition, be left to do the capital allocation.

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Mises Perspective:

• We must acknowledge that the business of government is not business. Restrict the role of government to enforcement of contracts between private players and protection of property rights
• Keep taxes as low as possible and maintain an environment of positive real interest rates to enable capital formation. Still better, get rid of taxing production altogether and move towards a consumption-based taxation system.
• Allow the marketplace and market regulations to determine the winners and losers rather than by government fiat.

Assertion 3: Limiting subsidy to 2 percent of India’s GDP

Pranab_da_ probably considers only the explicit cash transfers provided on food, fertiliser and fuel within this 2 percent bracket. But, by definition, any non-market related pricing of a good or service is a subsidy. Just consider the following examples

The operations of commercial entities such as Air India and Coal India inevitably have subsidies built into their operations. Air India subsidies competition by handing over profitable routes on a platter and the numerous bailouts are a subsidy provided to employees. Coal India, on its part, subsidies power companies as it is forced to sell coal below market prices.

In social-sectors like education and healthcare, the extent of subsidy gets worse. For example, it’s widely acknowledged that the salaries of public sector teaching staff are substantially (100 to 300 percent) higher than market wages - and this is without even taking competence and results into account.

It gets only worse when we move onto other issues. For example, expenditures on advertisements of government achievements are a subsidy to the political party in power; election promises of freebies are a subsidy to the political party that wins the elections.

And it’s tragic when we consider the non-financial subsidies. For example, it’s widely acknowledged that certain “less-than-honourable” skills are required to run certain industries, e.g. higher education, that are largely dominated by liquor barons and politicians.

Net-Net, the various subsidies could form a substantial portion, easily running into a double-digit percentage of GDP.

Mises Perspective: One should recognise that the real cost of government is not what it taxes, but what it spends and so one should limit government expenditures to some reasonable percentage of the GDP. At this point, we should be cutting government expenditure not with a scalpel, but with a chain-saw. Target a decrease of this percentage number as the economy grows (and a greater decrease in percentage during recessions. The Keynesian multiplier is a figment of imagination).

Conclusions

 The government’s economic think-tank would have to undertake a soul-searching exercise if we are to get out of the current predicament. Such has been the intellectual influence of Keynes and the powerful self-empowering /enriching incentives it has created that what seems obvious is actually a blind-spot to most government economists. Given that the solution would imply that they fire themselves and a lot of their colleagues in the bureaucracy as well as parliament, I must be in a state of hallucination to think it would happen.

With all these policy blunders, blaming the Greek crisis for our problems reflects a rather dry sense of humour on the part of Pranab_da_. That would have to be the most charitable explanation for his observations and were it not for the tragic consequences that lie ahead, maybe all of us could have had a laugh as well.

Shanmuganathan “Shan” Nagasundaram is the founding director of Benchmark Advisory Services - an economic consulting firm. He can be contacted at shanmuganathan.sundaram@gmail.com