Wednesday, August 14, 2013

Role Of Government In New Paradigm


The role of government must be redefined to abandon the many functions accumulated over decades where the government adds no value (even theoretically under ideal conditions) and focus on the basic functions of governance that only the government can perform, but have been neglected.  Right sizing of government requires both downsizing and re-focussing of government attention on essentials.

Down Sizing

 Downsizing of the government requires privatising of production, shutting down of control department and ministries and eliminating producer and middle class subsidies.  All these add to the power of government and thus undermine the power of the public and accountability of the elected representatives to the people.  This is particularly so when the power to harm is so much more than the power to do good. Use of such production units and producer & middle class subsidies for personal vote yielding populist measures is one of the reasons for fiscal bankruptcy. 

Privatise production

            The government must get out of the production of (what are technically defined as) “private” goods and services, i.e. those that can be sold to and consumed by individuals on an exclusive basis.  These are not “Public goods” in the sense that consumption by one individual does not diminish the consumption by another (non-rivalry) or are non-excludable, or they are “Quasi-Public” in that they meet the criteria approximately and have some element of externality.  For instance even though urban piped water & education are ‘private” good/service, I would define ‘clean drinking water’ as a “Quasi-public” good as consumption of dirty water can lead to public health epidemics.  Similarly literacy & primary education have externalities in that the entire society (including the educated) benefits from the expansion of the pool of literates. Further, in rural areas, even piped water and primary education may not be private good/service.
There are several reasons for this.  Firstly they can just as well be produced and sold by non-government (commercial, co-operative or non-profit) organisations, so there is no positive reason for government to produce them.  Their production has been usurped by a ‘Leviathan’ government in its unquenchable thirst for power.
            Secondly, the incentive structures in government are not conducive to efficient commercial operation.  The rigid financial rules (e.g. sale by auction) do not allow even the honest and sincere public servants to run producing enterprises in an efficient manner.[1]  The layers of government hierarchy (PSU/DPE, concerned ministry, cabinet & parliament) as well as the CVC and CAG system is not conducive to making management decisions in a complex economy or to risk taking in an inherently uncertain world.  Thirdly, the rate of return on the assets employed in these units is less than the interest rate that could be earned on the sale value of these assets and much less than the rate of return of similar units in the private sector. Note however, that the “resource rent” on natural resources such as oil that have scarcity value can & should be mopped up by government through a royalty or other resource rent tax, whether the producer/user is a government or private company.  The proper comparison for oil producer/user companies is therefore net of oil resource rents.
            Privatisation of competitive and contestable goods (including units producing civil & dual use items for defence forces) can be done with all deliberate speed, while that of natural monopoly (such as power distribution) must be accompanied by setting up of appropriate regulatory systems.  Regulators already exist for the financial system (RBI & SEBI), so privatisation of banks & other financial institutions (e.g. UTI) can be initiated without delay.[2]

Eliminate Departments

            Many areas have been de-controlled and de-licensed; yet the staff, divisions, departments and ministries set up to implement such controls and licenses continue.  These must be eliminated to remove the threat of ad hoc interference and red tape and root out the control mentality that has wormed its way deep into the government.  Similarly, there is no need for ministries and quasi-public institutions dealing with ‘private’ goods & services such as steel, sugar, fertiliser.

 Phase-out Non-Poor Subsidies

Subsidies must be targeted on the poor, which for this purpose should include the less well of half (50%) of the population.  Impact studies show that the poor benefit less then or at best proportionately to the middle-upper income groups.  Better targeting requires a systematic effort to eliminate both producer and middle class subsidies and search for channels that can be used to focus subsidies on the poor.
The origins of many subsidies have long been forgotten and they continue because large subsidies always build strong vested interests.  The fertiliser (Urea) subsidy is a good example.  Its original justification was to induce small and marginal farmers to adopt new HYV technologies, as higher fertiliser usage was an inalienable part of the HYV package.  Over the years it became a subsidy for large surplus farmers, particularly those producing food grains for the market.  More recently it has become a subsidy for fertiliser producers as the gap between farm price and world prices has disappeared. This subsidy can be eliminated by complete decontrol of fertiliser with the subsidy phased out over 3 years (say).  This will allow the fiscal deficit to be reduced and larger funds to become available for irrigation & rural infrastructure that helps all rural poor including small & marginal farmers. 

Refocus Government

Broadly speaking the government has three broad functions that it must perform for the economy and society.[3]  This is the provision of “Public” goods and services, the correction of “externalities” and “social welfare.”   The former has been most neglected over the past three decades.

Public Goods

‘Public good,’ is an economic concept with a precise technical definition, one element of which is “non-excludability” and another is “non-rivalry.”  The classic ‘public good’ (actually service) is ‘defence’ where exclusion is literally impossible and once provided everybody shares in it.  Other services that meet the definition are general administration, the judicial system, police, roads & prevention/control of communicable/epidemic diseases.   Though in principle government could charge individuals for the use of local roads it is prohibitively expensive to do so (economic non-excludability).  Rural roads, once built satisfy the non-rivalry condition in that they the traffic is very light (and they are thus empty) most of the time.  Inter-city roads have very strong element of externality (marginal cost ~ zero relative to average fixed cost), so that they are also considered ‘public goods.’ Similarly public health measures such as public (not individual) supply of clean drinking water, sanitation & sewerage, population control and public education about nutrition, cleanliness etc. correct negative externalities and are accepted as ‘public’ goods.  Similarly literacy & basic education have positive externalities for other educated people and can be similarly classified even though it does not meet the exclusion criteria in urban areas.[4]  Because of limits to divisibility and the sparseness of population, many basic infrastructure services (drinking water, primary education) in rural areas have very high average fixed costs relative to marginal costs and can be classified as ‘public goods.’[5]
Fifty years after independence the population coverage and the quality of supply of these basic services is pathetic and globally embarrassing. Much more attention, time and funds need to be spent on these basic public goods & services.  Government responsibility for supply means that government must provide the required funds but it need not produce all these services.

 Non-Governmental Producers

Private schools have played a vital role in the high educational attainment of Kerela.  Production of services must be entrusted to those who can supply the service most efficiently.  This implies that the poorest worst performing states have the greatest need to entrust the job to non-government organisations.
The UP government has covered all its districts with secondary schools for girls by giving a one time grant to any organisation that was willing to set up such a school.  Similarly there now exist non-profit organisations that can provide quality primary education at one-tenth the cost of the government system.  Unlike government schools where teachers do not show up these organisations guarantee that on completion students will be able to pass pre-specified tests.   Similarly the Gujarat government has contracted the running of several health centres to non-governmental organisations.  This has solved the problem of perennially absent staff and non-functioning centres.  Such organisations must be used wherever they are available to provide universal primary education & primary health services.

Public-Private Partnership

There are, also specific areas within these broad public service categories, for instance construction & management of jails, in which public-private partnership can be effectively used to improve efficiency.  Again the key concern should be efficiency & quality of output (“biggest bang for the buck,”) not ideology.

Institutional Reform

Defence, Judicial, Police and general administrative services can only be provided by the government, so that the focus has to be systemic reform and introduction of modern management practices for improving efficiency.  Archaic laws have to be repealed; archaic procedures modernised (written evidence-signed & sworn, limited adjournments based on prior written request & notice to counter party) to provide justice to those who have cases going on for as much as 30 years.  The Police system, which has become an instrument of political power for the ruling party has to be refocused on providing personal security & upholding the rule of law. Its slow but steady decline into anarchy has to be stopped and eventually reversed.[6] 

Correcting Externalities

Externalities are a known form of market failure even in a competitive economy and need to be dealt with through government intervention.   Apart from the externalities that we have incorporated in the concept of ‘Quasi-public good,’ the most important externalities relate to Knowledge and information & environment /pollution.  The significant areas in the former are Science & Technology, higher education in special fields of national importance, development of strategic technology (e.g. aerospace & nuclear)[7] and Research & Development and the spreading of knowledge especially in agriculture (information/extension).[8]  This is best achieved through a mix of government expenditures and tax/direct subsidies.  The optimal mix can be different for different sectors and also changes over time.  The private sector can play a much greater role in correcting these externalities at lower cost to the exchequer, but government will also continue to be an important player in this area.  Similar solutions apply to environmental externalities, of which control of water pollution is the most important from the expenditure perspective.

Social Welfare

The third important expenditure related function of government is social welfare.  The definition of Social welfare has a large element of context specificity, in that it cannot be defined independent of the average income & wealth of the country.  Equally there is a basic minimum that even a relatively poor, democratic country must ensure in the 21st century.  We cannot allow people to die of starvation or to be chronically hungry.  Society must also take ultimate responsibility for the old, infirm and disabled and for abandoned or destitute children.  Every citizen has the right to life, physical security, basic human dignity and equality before law and constitution.   The government has the duty to eliminate pockets of feudal oppression and bandit government that still prevail in parts of the country.[9]  Known criminals, dacoits & murderers cannot be allowed to publicly hold the law to shame because of their muscle power, political power or (sometimes ill gotten) wealth.[10]

Extract from, "A New Development Paradigm: Employment, Entitlement and Empowerment,"  Economic and Political Weekly, Vol. XXXVII No. 22, June 1-7, 2002, pp. 2145-2154. [  NewParadigm4nf ]

[1] One such secretary level officer told me of his personal experience of being charge sheeted for selling in the market, without due auction process, a by-product of the industry that had traditionally been dumped into the surrounding areas.
[2] Those who genuinely believe that government is to blame for recent financial failures, should realise that systemic tinkering or change of government will not change the basic incentive structures.  Similar, perhaps worse crisis are inevitable in the future if ownership remains in government hands.
[3] The issue here is expenditure related functions, not macroeconomic, tax and other policies.
[4] In general both basic public health & basic education services are more accurately defined as ‘quasi-public’ goods.
[5] Once a primary school is built and teacher provided, or piping for drinking water established, the marginal cost is almost zero (relative to the fixed cost).
[6] It has already reached a point where a beat policeman in Delhi can threaten a SSI producer with overnight theft of materials lying on his premises if an adequate ‘hafta’ is not paid to him.
[7] Technologies of power where normal commercial considerations do not apply and availability depend on geo-strategic considerations.
[8] Thus government must provide facility grants to R&D organisations and scholarships to PhD students in S&T. 
[9] ‘Bandit’ or ‘Predatory’ government is a particular form of pre-feudal government defined in the theory of political economy.
[10] The T&D mafia can arrange to steal half the power supply of the capital city of Delhi, its inspectors can institute false charges of electricity theft and set the DESU equivalent of the CBI on a doctor whose employee inadvertently charged his relative and a government servant has to approach the union power secretary to ensure installation of functioning (rather than a faulty) meter at his house, while commentators still refer to ‘pilferage’ & theft of power by industrialists. 

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