Modi's first task if he becomes PM: Define the limits and role of the state

Unless all the opinion polls have got it completely wrong, “Ab ki bar, Modi Sarkar” will become a reality on 16 May, when the counting begins.

This means this is the right time for Narendra Modi to formally draw up a 100-day action plan for the next government, with economic revival at the top of the agenda. He does not have to wait for the budget, due around mid-July, to set his agenda. In 1991, the new government started moving on reforms even before Manmohan Singh presented his budget. This is what Modi must do, since the window of opportunity will start shrinking once the various assembly polls start coming up one after the other - the Delhi one will probably come first right after the general elections, and it will be followed by Maharashtra and Jharkhand. Once elections get underway, politics will set the agenda rather than economics.

However, the first thing Modi and his team must grapple with is the philosophical one: how big a role should government play in the country’s life, and what should that role be? Since Modi is the author of the slogan “Minimum government, maximum governance”, he has to put flesh and blood into this philosophy by getting his fundamentals right. His can be the defining moment in the country’s life if he can figure this out.

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His main opponent, the Congress party has already indicated its view: it believes in an ever-expanding state, with doles and giveaways being the order of the state. Pictures of Rahul Gandhi standing with various classes of people show that the state will take on the old parenting roles of the feudal lord in some form or the other. Modi has the opportunity to define himself in contrast.

The context in which Modi needs to define the role of the state is global. After the fall of the Berlin Wall, most countries adopted the market economy model in varying degrees. But 2008 brought the importance of the government’s role to the fore once more, as the financial markets imploded in the wake of the Lehman collapse. Only governments had the power the act when everything went phut.

The Lehman crisis and its aftermath raised serious doubts about market economies and their ability to correct themselves. Questions tumbled out of the closet: what happens if powerful players hijack the market to create self-defeating monopolies? Can the state recede so far back that the private sector then becomes strong enough to even capture the state and regulators - resulting in what is called crony capitalism?

Once upon a time, the answers to the poser - private versus public, state versus individual - would be purely ideological. If you are a capitalist country, you would say the role of the state should be minimal. If you are a socialist or communist one, you would say the role of the state is paramount.

However, ideological certainties are now over. Just as the belief that socialism could deliver all ended with the fall of the Wall, the belief that capitalism will always prevail and that markets should be left to their own devices has died a quick death after 2008. Several new books have now been written about saving capitalism, including one co-authored by current RBI Governor Raghuram Rajan (Saving Capitalism from the Capitalists), and another by Joseph Stiglitz (The Ideological Crisis of Western Capitalism).

Everyone now accepts that the state can no longer be wished away or downsized even in capitalism. If Karl Marx made the outrageous assumption that in the final stages of communism, the state would wither away, free market economists were equally wrong in assuming that if only the state would retreat or wither away, capitalism will deliver all. At the very least, capitalism needs stout policing and a strong government as countervailing power.

The big debate now should not be about socialism or capitalism, but the right role of the state, and what limitations should be placed on its expansion so that we get the best of both worlds: a vibrant market-based economy, and a society that is not loaded in favour of the rich.

There are, of course, no short answers beyond motherhood statements. But these motherhood statements are important, nevertheless, and they establish the principles on which states should decide their roles.

Just as the core principle of communism is “from each according to his ability, to each according to his need” the central principles determining the role of the state in a market economy should be a sum of the following: the state should do what private parties and individuals cannot do; it should not do what others can do better; where possible it should be an enabler rather than a player itself; and, most important, it should not overextend itself, for it is not the job of the state to solve all human problems in existence.

Even if we accept these broad principles, it will not be easy deciding what a state should do, for the answers would vary depending on a country’s stage of development. For example, is providing food subsidy the job of the state or should the state focus on creating growth so that people find worthwhile jobs and are able to feed themselves? Should the state set up lots of educational and health institutions or should it play a more recessed role?

We, therefore, need to sharpen our definition so that we have greater clarity. Ajay Shah of the National Institute of Public Finance and Policy suggests one approach. He says that the state should prioritise the provision of public goods over private goods.

A public good means something whose benefit, if extended to one or many persons, will not reduce someone else’s ability to enjoy it. A robust defence policy is a public good. It protects both you and me - and not just one of us. A healthy internal policing mechanism protects both you and me from criminals. If the streets are crime-free, it is not a benefit only you enjoy. I get it too. So does a good legal system. A strong currency protects the value of everybody’s money - not just the money of the rich.

In contrast, a private good is something where consumption by one will mean denial to another. If I give you free food because you are poor, someone else cannot consume the same item. Moreover, the tax resources spent on providing free or subsidised food to you will have come from taxing someone else.

If we accept this principle, it would mean the first job of the state should be to provide the most important public goods - which is the basic reason for its existence. Private goods - including subsidies for food or fuel or fertiliser - come much, much later.

However, the meaning of public good can change as a country gets richer, and generates more tax resources to play around with. At different stages in a country’s progress, currently private goods like good education or good healthcare can become public goods given to everyone.

Put another way, public goods are universal goods - and how much of state investment must be made universally available depends on what stage of development you are in. For example, free hospitals for basic illnesses can be a public good in India; but free psychiatric care may not be. The latter is more appropriate to a developed country like the USA, where mental illnesses become as important as physical illnesses.

Another principle of value in deciding the role of the state is efficiency: who can do the job best? Outsourcing defence or local policing to private parties may not be a great idea anytime, but does the state need to be making steel, producing coal, or running the railways, banks or bus services?

Again the answer cannot be in black of white. The state would be right to get into these activities if no one else is willing or able to do it. This was the case in the 1950s, when the private sector did not have the capacity to build steel plants or run coal mines. The state can, and should, withdraw from such commercial activities if private parties are ready for the challenge. This is the state India is in now, where private parties can easily produce coal and steel and run airlines and railway services - but these remain inefficiently run by the state. The time is ripe for the Indian government to withdraw from these monopolies in stages.

The third aspect is enablement and supervision. If we accept the reality that the state need not get into everything, it does not follow that it must do nothing. For example, private parties may be able to set up profitable schools, but the critical question is whether these schools serve only a few or the multitudes? And even if it is the latter, are these schools providing good value or just providing a place to send the kids from home? States have to thus create the right incentives and environment for good schooling. They have to enable good education.

Similarly for jobs. Should the state try and create jobs itself (even useless jobs like NREGA), or create the right conditions where the private sector can create jobs in plenty? Surely, it should be the latter. When the state directly creates jobs, it also creates a moral hazard: it can never dismiss employees even when these jobs are irrelevant to the economy. Since a state is supposed to be an ideal employer, no employee can ever be dismissed for anything other than very bad behaviour.

The Indian reality is that the state has been extending its ambit to private goods (free food, cheap fuel, free what-have-yous) and reduced its capability to provide public goods (law and order, good defence, and an efficient legal system, good primary education and basic healthcare). Right now we need to roll back some of the contours of the mai-baap state. An ever-expanding state will inevitably lead to failure in providing essential functions.

If Modi truly believes his own slogan, he has to define what the state will do, what it seldom will, and what it never will.

(Some parts of this article were first published in Entrepreneur India)