The Hindu Business Line : Failed by fallacies

Though the previous government left the economy in fairly good shape, it did not get the mandate to rule because of increasing rural-urban, rich-poor disparity and rising unemployment, particularly among the educated. These defects were caused because of several conceptual fallacies, says P. V. Indiresan, explaining them.

THE FINANCE Minister, Mr P. Chidambaram, has sportingly conceded that the previous NDA government has left the economy in good shape. As explained in the previous article, in spite of its good economic performance, the NDA lost mainly because of three flaws: (a) increasing rural-urban disparity; (b) increasing rich-poor disparity and (c) increasing unemployment, particularly among the educated. These defects have erupted because of several conceptual fallacies.

Fallacy 1: Higher education is a right and should be available to every one who seeks it. Such education induces youth, particularly graduates, to lose all interest in their traditional family occupation. They acquire some book learning but no skills to land jobs. Ever increasing unemployment among the educated (estimated by some as high as 20 per cent) is the consequence.

The remedy is simple: Regulate college (even high school) admissions; limit their number to the figure that secured employment (or admitted to still higher education) in the previous year with a correction for anticipated growth. That rule will halt growth in unemployment. It will also save considerable wastage of time and money on unproductive education.

Unfortunately, unlike in the US, where private colleges operate as a social service with a large element of charity, in India, education is big business. Most colleges (particularly, professional colleges) are operated for profit (often illegally) by petty politicians. When admissions are limited to what the economy will support, most such colleges will have no option but close. Our politicians will not give up easily the bonanza they are enjoying.

Limiting college admissions is a negative approach. Ideally, the economy should expand fast and meet the aspirations of youth for higher education and for white-collar jobs too.

Fallacy 2: Labour has a right to perpetual increase in wages. Increase in wages expands the economy and thereby creates more employment. Jobs are created when more and more goods and services are produced. However, they are sustained only when there is money to buy all those goods and services. It would then appear that the market can be expanded simply by raising wages. The Fifth Pay Commission did exactly that. As we have seen, pay increases not linked to productivity merely produce temporary euphoria and end in permanent pain.

In truth, sales increase when real prices decrease. For instance, suppose all goods and services are priced not in rupees but in terms of the PER Capita Hourly Income (which I like to call this Perchi). Only those goods and services whose price in Perchis decreases will sell more.

Real price depends on production costs of which there are four: material, labour, capital and transactions. Then, more goods are sold, more jobs are created when the price of labour — and of material, capital and transactions — decreases, not increases. In other words, growth increases when materials are used more efficiently, the productivity of both labour and capital improve, and transaction costs decrease. Then, (a) wages may increase but labour productivity should increase even faster, and (b) investment may be more but ICOR, the Incremental Capital-to-Output Ratio, should decrease.

Fallacy 3: Central subsidies alleviate poverty: The keyword here is "Central". Experience has shown that a remote government office cannot identify the poor accurately; cannot target them effectively; cannot prevent leakage of subsidy. The poor do need help but the gigantic bureaucracy of the Central government is not equipped to provide such aid. A new dispensation is required.

In the olden days, during the times of famines, autocratic rulers helped the poor by building palaces and other monuments. The Jodhpur palace, built some years before Independence, is one such example. Food-for-Work programme has not performed satisfactorily because the works chosen are such that they do not last long the way monuments do. The existence of monuments is permanent proof that work has been done. That proof that the work has been done is proof that food also has been distributed.

Food-for-work works under three conditions: (a) payment is in kind. (b) The work done is transparent, leading to a permanent visible asset. (c) The payment is supplementary income only and not the total income; no worker can live on food only; additional income is necessary to pay for other purchases.

Payment by perquisites is the generalisation of the principle of Food-for-Work. Economists frown on the very idea of perquisites, and condemn it as an inefficient allocation of resources. On the other hand, the higher one climbs, the larger is the income share of perquisites. Virtually the entire income of a Cabinet Minister is in the form of perquisites. A poor coolie has no perquisites at all, unless sleeping on the pavement is taken as a perquisite. If perquisites are good for Cabinet Ministers, company directors and top bureaucrats, why should not the same rule apply to the poor too?

Perquisites are thrice blessed. They enrich the recipients; they create jobs for those who produce perquisites. In addition, perquisites inherently enjoy economies of scale because they are supplied in bulk.

Hence, they have lower transaction costs leading to lower ICOR. For the poor, particularly the urban poor, land for dwelling, is a valuable perquisite. Unfortunately, the following conceptual fallacy has stopped the government from offering those to the poor as perquisites.

Fallacy 4: House owners enjoy unearned income and deserve to be taxed heavily. Incidental corruption is collateral damage that is unavoidable.

Among all sectors of the economy, housing has probably the highest transaction costs. Every kind of administrative obstruction imaginable is placed in the path of house ownership. On the other hand, half the net capital formation is in the domestic sector, almost entirely utilised for housing. Then, any reduction of housing costs will improve the productivity of half the nation's capital investment, and thereby improve ICOR. That is as good as increasing savings, something we are unable to do. Reducing transaction costs of housing will increase growth rate; it will multiply jobs at all levels, from the unskilled to the highly professional.

We already have the rule that employers should provide Provident Fund, healthcare and even Leave Travel Concession. To these perquisites, we should add shelter (at least, land for shelter). The cost need not be a burden on the state; it can be met from a small cess on the organised sector.

Outside of agriculture, organised sector employs 20-25 per cent of the workforce, and pays top wages. Those in the unorganised sector earn much less and will be happy with smaller plots. In general, the bottom 40 per cent of the population occupy a third to a fifth of the land taken by the top 20 per cent. Therefore, a mere 15 per cent cess on the land used by the top 20 per cent (namely, the organised sector) can subsidise land costs of the bottom 40 per cent by 50-75 per cent, and make it affordable even for the poorest workers. Then, consider the following regulations: (a) It is a crime for the organised sector to have any employee residing in a slum. (b) The organised sector will pay a 15 per cent cess on the land it needs to house its employees. (c) The cess will subsidise plots for the bottom 40 per cent of the workforce in the unorganised sector.

Offering housing (at any rate, land for housing) as a perquisite satisfies all three conditions listed above: Land is an easily verifiable permanent asset. It is payment in kind. It is a valuable supplement to wage income.

Incidentally, unlike Food-for-Work, which has to be offered everyday, it is enough to allocate shelter once in a lifetime. Hence, administratively, this aid to the poor is easier to handle than Food-for-Work. It would help if land includes protected water supply, sanitation, educational and healthcare facilities as well as daily commuting.

Fallacy 5: Economic expansion occurs best in crowded cities. Resultant slums are unavoidable.

Crowded cities are not merely an ecological disaster; they are also a break on the economy. Crowded cities like New York and Mumbai sell fewer cars and household goods even though they are the richest cities in their country - for the simple reason there is not enough space to keep them. Greater the congestion, lesser will be the purchasing power of the rupee. Merely by moving 20 km from Delhi to Gurgaon, unit costs of housing decrease five times. For the same incomes, people will then have larger disposable incomes; they can afford larger houses and can buy more. Hence, producers will have larger markets and more profits. Thus, the opportunity costs of congestion are high. Unfortunately, our industrialists have not realised this elementary truth.

By 2020, India's urban population is likely to double. We have two choices: (a) expand existing cities or (b) relocate where land is in plenty. If we choose the first option and expand existing cities, ICOR will worsen, and so will rural-urban disparity. If we choose the second option, ICOR for half the capital investment will improve several times; over all too, the improvement will be substantial. Rural-urban disparity will decrease; growth will increase to create many more jobs.

(To be concluded)

(The author is former Director, IIT Madras. Response may be sent to: indresan@vsnl.com)

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