Sailing Too Close to the Wind: Cash Pay Out in lieu of Subsidies

India seems to be on the verge of a important threshold, especially in the way the government approaches the manner in which subsidies are delivered to the poor. It has been estimated that the total quantum of subsidies that the government provides are approximately Rs.116,000 crores (nearly US$2.57 billion). Food and Fertiliser subsidy constitute the lions share of the subsidies - about Rs.100,000 crores (nearly US$2.22 billion). There have been increased calls for the government to simply pay subsidies as a  cash grant in order to plug the leakages in the system. A oft quoted premise on which the leakages are calculated is the famous 1985 observation of Mr.Rajiv Gandhi, the then Prime Minister, that in India only about 15% of the subsidies actually reach the intended beneficiaries. Cash payout is increasingly seen as the panacea for inefficiencies that plague the government delivery mechanism. Interestingly, the leakages in the system are still calculated on the basis of the 1985 observation.

It may be premature to claim that most of the money is lost due to leakages. On the contrary, i would argue that while the subsidies delivered in their present form may be inefficiently utilised, it would be wrong to argue that it would more efficient and less of a burden to the government to simply pay cash to beneficiaries. I understand that this may be a unpopular argument and may be against the conventionally accepted wisdom, but I am a firm believer that we may be premature to move away from the present system. It may be more profitable for the long-term health of the Indian economy if the government worked towards improving efficiency rather than simply dismantle the present system. The argument against cash subsidy is not simply related to its economic logic but is also based on various other socio-cultural and political conditions/logic based on ground realities/factors. Market fundamentalists and ardent believers of efficient markets love the notion that government should simply provide a cash dole and wash its hands from other welfare measures thereby reducing its burden in the long-term. But, unfortunately we live in a society which is rife with inefficient markets (if they exist), plutocracies (or at best oligopolies), and a creaking legal-institutional framework that is inefficient. The enthusiasm that seems to have encompassed those clamouring for cash payment of subsidies is akin to sailing too close to the wind. It definitely makes me queasy. An attempt is made to elucidate some of the problems that a cash dole will face on a day-to-day basis. I believe that the growing optimism that UID will help better delivery of cash subsidy to the intended beneficiary may be misplaced (at least to a certain extent). Hopefully these fears will prove to be unfounded in the long-term.

While, leakages in the system are undoubtedly high, I would not base any calculation on Rajiv Gandhi's 1985 observation to be the holy grail for calculating leakages in the present. This premise is based on the simple reason that there has been an all-round increase in efficiency in the way subsidies (as well as government services) are delivered to the poor and also due to the fact that due to greater information flows (as well as other factors), the poor themselves have become adept at claiming the benefits due to them. While this may not be true uniformly in the whole of India, there are a large parts of the country where due to a combination of factors they are now able to access various benefits that have been earmarked by the government. Due credit also needs to be given to the government machinery, which due to varied reasons, has become more efficient and more sensitive to charges of malfeasance - at least on more occasions than in the past. This is not to claim that corruption has decreased, instead it now takes different forms and has to an extent become more institutionalised.

By no means would I argue that the direct cash subsidy will not reach the poor. It may just complete that purpose, but my objections are more based on the end of the funds rather than anything else. With the UID and a technology savvy banking sector funds reaching the bank account of the intended beneficiary is the easy part. Once the money is credited, it would be a mistake if we believe that people in their enlightened self-interest would use it in the best possible manner. While I do not want to be patronising in my claims,  but the ground realities in India may be completely different. The argument against direct cash payout is based on observations during the course of personal field studies in the past as well as the recent incidents that have come to light in Andhra Pradesh (especially during the microfinance crisis). In Vijayawada region, there are financiers who lend only to government employees (in this case: railway employees) and they come to collect their dues exactly on the day salary is credited to the accounts of employees. Interestingly, the financier not only requires a borrower to sign a blank promissory note(s) but also to submit  the Bank Pass Book and the Cheque book (with a certain number of signed blank cheques). During the recent Microfinance Crisis there were reports that came to light during government inquiries that some MFIs also kept the ration cards of the borrowers with them as an additional pressure tactic. Indebtedness is undoubtedly high and with direct cash pay out the lending business will boom because the financier simply knows the best time to collect the due. Once the money is withdrawn there is nothing that the borrower or the government can do for the simple reason that they will have no control over the end use of funds. These issues may not be peculiar to one city, and are bound to exist in different parts of the country, if not in all parts of the country. Mandatory Regulatory requirements that pledge signed affidavits about the end of funds (like IPOs) are successful on paper, but not in real life.

Despite its leakages, the present system of distributing subsidies has a rather impersonal element, in the sense that it goes to nearly everybody who can lay claim to it - even if it means cutting corners by submitting various false claims. The more vociferous and more efficient ones with an uncanny ability to lobby for them have a  greater the chance of laying their hands on the benefits in the present system. However, cash subsidy due to the possibility of customisation can lead to extra-economic considerations (especially political, social or cultural issues) and stereotyping that could simply exclude those who are not in the good books of the ruling party. These considerations may be based on faulty perceptions but there is a greater probability that victimisation may become the norm rather than the exception. It is not difficult to foresee a smart politician withholding benefits due to people who may have voted for an opponent.

A more important long-term issue may well be that, one need not be surprised if the government actually ends up paying two times: the first in the form of the well intentioned direct cash subsidy and second as an additional cost that it may have to bear to clean up the mess that it would create. The second unintended cost may have to be borne despite denials because of the simple fact that in a democracy 'the politics of the governed' (to borrow the title of Partha Chaterjee's book) may make greater compulsive logic than balanced budgets and sound economic logic. Add to this the unknown consequences that may arise due to diversion of money by the beneficiaries themselves in order to overcome short-term liquidity problems that may face due to contingency requirements that may fortuitously arise at that particular moment (when the government subsidy money is credited), etc. Moreover we never know how to index the actual cost of production to the actual benefit that the government may want to payout.

Fear of future scams need not be a justification for rocking the boat today. The auction of 3G Spectrum clearly showed that it is possible to conduct a transparent sale of public property. Why not extend it to any process which involves large sums of public money? It is imperative to note that a lot of the above arguments are based on various assumptions that may not materialise, however, it is important to create sufficient checks and balances to avoid these pitfalls. Thus, it may be more prudent for the government to increase efficiency in their current delivery systems rather than simply switch to a system of direct cash handout. Just because we lack a solution to the present problem need not be a ground for instinctive judgment for a large scale shift into an unknown future - at least not without sufficient successful experimentation. In any government action, there is bound to be one section that benefits and it would be fair to believe that a direct cash payout would be a great benefit for those in the lending business: a direct payment would mean that it was probably never so easy to collect a loan.

Theorising Finance: From the Current Inflationary Spiral to Microfinance

The more one tries to objectively analyse some of the major economic challenges of contemporary economy, the more they are forced to conclude that the current prescription for overcoming these challenges is wrong. There seems to be an indulgent unwillingness on the part of various policy makers to deal with more fundamental structural issues that not only caused the crisis but continue to plague the global economy. The inflationary spiral in the Emerging economies seems to be a consequence of rampant financialisation that has climbed on to the bandwagon of shortages caused by a supply chain that may have become more obsolete. Add the consequences of nature’s fury and we have the broad contours of what may be a future crisis in food security. The seemingly relentless rise of financialisation has impacted economies of various hues, far beyond the shores of the more mature economies. Till recently, the conventional wisdom seems to have believed that financialisation will not have an adverse impact on the emerging markets, on the contrary, a number of observers seem to have believed that it would be beneficial due to general paucity of capital in most of the emerging markets. The recent inflationary spiral as well as some of the problems in some sectors of the increasingly financialised economy seems to indicate otherwise.

The post industrial-revolution production process requires an every increasing supply of money to be the means that would not only enable the production process but also convert profits into an easily mobile and socially acceptable form along with its commoditisation. The production process therefore entails Money to purchase Commodities and then reconverted to buy more commodities (or C-M-C) format . Broadly, this enables those who have no use value for what they produce (and/or their excess production) to exchange them for other commodities that have greater use value. Therefore, the fungibility of money is what gave it its essential characteristic. It is this quality (fungibility) of money enabled it to become the pivot on which contemporary industrial-service complex has been assiduously built. A general exchange of commodities becomes profitable only when the cost of this capital is low and is easily available and when money can be transferred over vast distances at short notice.

Commodities (especially those used in the production process) have an important characteristic: as they are consumed, they disappear from circulation. But money continues to circulate. Though over a period, some other commodity takes the place of commodity that has been consumed, in the short-term this creates a semblance of shortage, leading to prices to rise. In theory, the total quantity of money in circulation should be equivalent to the total amount of goods and services produced (or the aggregate price of the commodities). Money that is circulating can disappear only when the underlying asset (like say factories or companies) become economically unviable. In the case of financial assets, it can disappear only when underlying market value starts to decline. The bursting of a bubble are all excellent examples of how money can disappear.
The recent years have seen a major shift in the operational dynamics of finance. The financial sector’s (especially the USA from where global finance is mostly centred along with UK) profits and debts have increased exponentially over the last few decades. The debt outstanding in the financial sector has increased from US$504.91 billion in October 1979 to the present US$14.44 trillion by end of July 2010 after reaching a US$17.11 trillion by end of October 2008.

Corporate Profits in USA after Tax (in Millions of US Dollars)

Year	Total	Finance	Manufacturing
1980	166,352	14,805	55,217
1984	171,077	10,040	52,176
1987	192,658	23,072	48,720
1990	266,263	39,610	66,772
1995	466,458	83,509	112,440
1999	521,730	108,171	97,013
2000	507,379	106,474	91,788
2005	1,227,774	192,758	141,462
2006	1,349,453	171,148	195,519
2007	1,292,890	98,826	163,243
2009	1,061,818	32,294	59,366

The centrality of finance is best illustrated by the fact that during the period 1973 to 1985 the financial sector never earned more than 16% of domestic profits, in contrast in this decade, it has averaged 41% of all the profits earned by businesses in the U.S. In 1947, the financial sector represented only 2.5% of our gross domestic product. In 2006 it had risen to 8%. In other words, of every 12.5 dollars earned in the United States, one goes to the financial sector.

The above historical perspective enables us to understand the recent changes that have had a cascading effect on other aspects of the economy. To buy commodities, one need not posses actual commodities as in the past. Instead financial instruments provide sufficient exposure either exchange traded funds or even derivative instruments on exchange traded funds. These financialised commodity products means that non -consumption oriented fund flow now has a central part in the prices of commodities in the market place. Securitisation has only added to the allure of financialisation. Add in Quantitative Easing in the Western world with easy money conditions in China and India (where M3 has grown at an annualised rate of approximately 16-20 per cent) and you get an idea about the amount of money sloshing around.

Investing these large amounts is a problem. The very nature of finance is that it needs conducive conditions such as peace, tranquillity and more importantly sufficient clarity about the future returns over a number of years. Clarity on such issues not only enables greater availability of finance but also at a low cost. Institutional protection only enhances the possibility of finance to circulate freely thereby enhancing the attraction of particular countries/economies. There are two important changes that seem to be taking place. At one level we have a large segment of the economy being starved of capital due to economic problems in western world while those at the highest level of finance value chain have ever greater access to institutions that have an ability to create this money supply. This has resulted in large amounts of money looking for a better return, with some attempting to replicate the returns over the past few decades – a fallacy that they will realise soon. Unfortunately, the large institutions desperately require these larger return for a variety of reasons. Barclays Capital estimated that assets under management of commodity funds had jumped to US$224 billion by end of October 2009 (while in 2008, when oil was US$140, they amounted to US$270 billion). By end of 2010 Barclays estimated that the investments had jumped to US$360 billion. A EU report recently pointed out that institutional investors have increased investments in the commodity markets from 13 Billion Euro in 2003 to 170-205 billion Euro in 2008.

Global Speculation to Microfinance
Finance by itself does not produce anything but facilitates production of goods and services. The cumulative net result of this process has been that over the years, finance has been transformed into a global commodity due to the process of securitisation. Advances in computing technologies have vastly aided the mobility of capital, thereby reducing returns and forcing capital to take greater risks for smaller returns. The consequences of this have been that it has not only increased the capital resources available for lending, but it has also forced capital to move from the core of advanced countries to the periphery (emerging markets) as well as other asset classes. Lending practices have not only become less cumbersome but also more liberal with a growing focus on attempts to lend to those who in the past were considered to be risky borrowers (subprime, Microfinance, etc).

However, if large amounts of capital, (especially global capital), are to be invested or channelized, it would require efficient process where it can enter and exit relatively easily and where the payment and repayment mechanisms are transparent and easy. This transparency includes those in the realm of institutional framework, including property relations and legal structures vastly reduces their cost of operation. A good example is the case of the Indian stock markets. Once the stock markets were transformed through the introduction of screen-based trading, introduction of rolling settlement and de-materalisation of shares, billions of dollars of foreign capital started flowing into India. Hence, creating this channel is important. Local capital flows will have synchronised to national and global capital flows. It is pertinent to note that the government’s task of improving economic development will be easier if they facilitate this development. Historically, it is clear that these channels if not created and policed by the government will be created by private players.

It is precisely this channel for financial flows that are causing the inflationary spiral in food articles and problems in the sphere of microfinance. Microfinance has only one ‘innovation’ to its credit: it has deciphered a route that enables major financial institutions searching for additional returns to channelize their capital. The fact that this process of channelization speaks the language and the framework that global capital is comfortable with has helped matters for the indigenous microfinance companies.

One fact that has often been missed is that, unless the policy makers find a solution to financialisation, they may not be able to end the inflationary spiral. Enabling speculation without buying commodity, which hitherto were not possible without physical possession of the commodity, now enables people in different parts of the world to buy any commodity exchange traded funds. Financialisation has facilitated the process of thousands of investors, worldwide buying financial products that derive their value on other commodities (like Wheat, Cotton, copper, lead, etc) in quantities that they can never even dream of consuming even a fraction of what they buy in their lifetime, leave alone one year. That is exactly what is happening today and this is unlikely to change in the next year or two. While we lament the consequences of financial players pushing up prices or creating complications for the poor, it may be worth remembering the consequences when the financial herd stampedes out of a particular market segment.