Spend it like a government

A perennial question all governments have to grapple with, especially in developing countries like India, is how to spend the limited money it raises by way of taxes and other sources. The means are modest and the claims on resources are many.

Here’s an experiment that gives an ample hint. Imagine you are the top government official in a poverty-stricken village with the mandate of improving the lot of the people there. You have at your disposal a very modest grant from the state budget but full freedom and authority to decide how it should be spent. This being a thought experiment, we assume that your intentions are noble, and that corruption is not part of the equation. In the course of your duties, you come across the following cases where the money you get from the government can be well spent.

There’s an elderly gentleman living alone, in failing health and badly in need of expensive medical care. Next, there is a tragic case of a pregnant young widow with no means of support, whose husband has died in an accident. The third case is that of a family with a young kid in school where the husband has recently lost a job in a city textile mill. He now survives on menial jobs and feels he must pull his son out of school. And lastly, there is an ambitious young man who works in the city and would like help with the capital to get started with his own grocery store in the village.

The funds at your disposal are sufficient to support only one of the above claimants and no more. Whom do you pick? Take your time and think over it. In the meantime, here is my conclusion.

Societies where the prevailing value system mandates the flow of scarce resources towards any of the first three claimants—does not really matter which one—are those likely to remain poor and backward for extended periods of time. The society which makes it easier for the ambitious youngster to have a first claim on the funds would be in the forefront of countries breaking out of poverty and underdevelopment.

Why is that so? Government expenditure is most effective in promoting the long term and sustainable welfare of its people when there is a multiplier involved. In other words, when you spend the money, not only must it do good but the good in turn must lead to other good things coming out of it. More precisely, government spending should head in that direction where the multiplier is the greatest among the competing alternatives.

Here’s another way of looking at it. Whatever be the ideological stance, all government spending on social initiatives has one thing in common — they begin with the intention of doing well to the people. But, having started from this common ground, the outcomes vary widely. So, what gives way?

In simple terms, it’s about the intended consequence that you start off with versus all the unintended consequences you land up with. The intended consequence can be transitory; the unintended consequences are what you end up living with for a long time. Even as you think you have solved that one big problem, you create incentives and disincentives that go on to alter human behaviour in ways that cannot be easily predicted at the outset.

Here’s a stray (and stark) example of how unintended consequences play out over the long term, spanning generations. In the cradle-to-grave welfare states of the West, the state takes care of you in your old age. Is it a coincidence, then, that they are up against a rapidly aging population and a fall in birth rates so precipitous it is no more adequate to meet even replacement levels? S. Gurumurthy, a noted commentator on economic and political affairs, believes not. The welfare state is to blame for the declining birth rates, he says. One of the incentives for the family to stay together and have more children is that we’d like to make sure there is someone to look after us in our old age. When the state takes over (“nationalises”) this function, there is no more compulsion to have children (or even stay together). As Gurumurthy puts it, “what started off as support to families slowly expanded to supplant the families themselves.”

And so, what differentiates the successful policy measure from the failures and the tired clichés is how the first order consequence gives way to second, third, fourth (and beyond) order consequences, where all these put together, and on balance, leave behind a lasting positive impact.

In the given example, there is clearly no multiplier at work in aiding the elderly gentleman. There is some long term multiplier in the case of the young pregnant widow and that of the family with the school going child. But none to the same extent as with the young chap who wants to invest in a village store, with all its potential for fulfilling a real need of the villagers and of kick-starting the local economy.

The funds given away to the first three cases would essentially constitute charity and would necessarily entail more of such spending in the years ahead with little visible difference to the village economy at large. On the other hand, the youngster would require money only for only this one year to get started, which leaves you free to fund other deserving cases in the coming years.

Moreover, the store saves time and money for villagers who would otherwise have to make periodic trips to the town to stock up on groceries. And that’s not all. As business takes off, he may hire a local villager to assist him, say, the man who’s lost the textile mill job. And when that happens, your task for the next year becomes easier because there is one less claimant for your budget. What began as four people in the line staking their claim on your funds is now down to two. The village is on the path to development.

In a sense, what I have outlined here is a simple (perhaps simplistic) example of that eternal clash between the heart and the mind in matters of economic policy. This is also, loosely, the clash between the liberal approach and the conservative preference. One is all about feelings and emotions and those essentially fuzzy notions of justice and equity. The other side appears heartless and cruel to begin with, but over the long term works way better for its people.

In India, improbable as it may sound, something like this actually happened and with remarkable success. Back in the mid-sixties, during the early phase of the Green Revolution when the country was reeling from food shortages and from the ignominy of the PL-480, it was consciously decided that the target group for spreading awareness about the use of high yielding varieties of seeds would be not the poor marginal farmer but the relatively better off farmers with larger land holdings and better education. It was reasoned, quite correctly, that these farmers would be in a better position to assimilate the new techniques and deliver results. In the event, one of the criticisms against the green revolution is that it increased rural inequality. But considering that it freed us from the food crisis and dependence on PL-480, the exercise was well worth it. That’s why, to this day, the Green Revolution remains one of the brightest spots in our post-independence story.

It’s an elementary lesson we in India have trouble figuring out. Policy making has to be guided predominantly by reason. When you bring in the heart, what you get is a palliative and never the bitter medicine that actually cures the disease. A government that defines its business as attending to sob-stories is never out of business.