Suman Bery: The Delhi consensus

The UPA's first Budget reflects current development fashion. Can it deliver growth

India has long influenced thinking on economic development. In turn India has also been more open to international intellectual currents than our apparent intellectual xenophobia might suggest.

Thus India was central to the critique of imperialism mounted by the Marxists, starting with Marx himself. The Nehruvian mixed economy provided the template for most of the British colonies, and for the World Bank's transformation into a development bank in the 1950s and 1960s.

As East Asia flourished in the 1970s and 1980s, India became the poster child of the perils of a closed economy. Today, debate rages between liberalisers (Panagariya) on the one side and institutionalists (de Long, Rodrik and Subramanian) on the other on why growth accelerated in the 1980s.

The recent Budget is the concrete expression of the current thinking of a party that has been out of power some eight years. On the premise that ideas are second only to interests in shaping policy, it is worth examining the Budget to see what conceptual framework, if any, animates it, and to link this with international intellectual currents.

Given that Budgets largely are (or should be) about public finances (revenues, expenditure, deficits and taxation) I will limit my observations to these areas.

A positive aspect of the Budget is the apparent commitment to fiscal consolidation. I say "apparent" for several reasons. First, the focus is excessively on the revenue deficit, rather than the fiscal deficit (or the growth in the debt stock).

Second, the revenue assumptions for the remainder of this year do seem very optimistic, even assuming a buoyant economy (although we should trust the expertise and integrity of the revenue department).

Third, credible fiscal adjustments need to be balanced between revenue and expenditure measures, whereas here revenue growth contributes the bulk of the adjustment.

Some commentators have expressed surprise at this commitment to fiscal prudence. Yet the reality is that centre-Left governments have in recent years been more fiscally conservative than those of the Right. The cases of Clinton/Rubin and Blair/Gordon Brown come to mind as examples of the former (among Left-ish regimes Germany is perhaps an exception). The growth dividend to be earned from such fiscal conservatism is captured in the phrase "expansionary fiscal contractions" which is what we have witnessed in both the UK and the US.

It may be mentioned that fiscal rules such as the Fiscal Responsibility and Budget Management Act referred to by the finance minister are in part designed to provide medium-term credibility to such adjustment, and thereby enhance the growth dividend from fiscal prudence. Unfortunately the Indian legislation is probably too weak and pliable to be of much use in this regard. This is exemplified by the decision of the finance minister to defer the target date for a zero revenue deficit within days of notifying the rules under the Act. This is not just an Indian problem, as demonstrated by the collapse of the Maastricht treaty in the Euro zone.

This view of aggregate fiscal discipline is different from the Keynesian view (adhered to by more than one distinguished columnist of this paper), which argues that, in the presence of unemployed resources, and particularly with an open capital account, the aggregate fiscal deficit (or even the stock of debt) is irrelevant.

Surprisingly, even amusingly, this view, previously considered socialist poison, is now championed by the Right, exemplified by the present Bush administration.

Turning next to public expenditure, the Budget (and the National Common Minimum Programme) stresses the importance of raising expenditure on human development, together with targeting of subsidies, particularly of food.

There is also reference to the duty of the state to provide guaranteed employment. An additional politically correct touch is the commitment to examine gender budgeting for the future.

This view of expenditure priorities would certainly find favour with today's donor community, given their commitment to achieving the Millennium Development Goals. (This government would do well to review the decision of the previous government to reject several small, though significant, bilateral donors, which was done out of an exaggerated sense of national honour.)

A couple of observations are nonetheless warranted. First, the stress on expenditure tends to assume that under-consumption of these services (particularly education) is primarily a supply-side problem.

Yet there is substantial evidence from both India and other countries that the problem lies also with demand. Parents simply don't see the return to education as worth the investment. The solution to this is faster growth and more flexible labour markets.

Second, where health is concerned, most experts would accept the importance of a public role in health-care financing, but less so with direct health care provision.

In both education and health, the issue of direct state provision versus empowered choice remains fiercely contentious, as exemplified by ongoing debates in Britain and France. It is complicated by the fact, which surely applies to India, that public servants represent an important class interest in and of themselves.

Similarly, income-based targeting is neither trivial nor innocuous: it is difficult to do properly, and in many countries (such as France) is resisted as being socially divisive.

Finally, with respect to the employment guarantee programmes, these are most effective if they are self-targeted, and this can best be done if the daily wage is sufficiently low: not necessarily at the minimum wage. Significantly the commitment to the minimum wage was not repeated in the Budget speech.

It is on the revenue side, particularly in indirect taxation, that the Budget falls furthest short of best practice, and where it is likely to exact the highest growth penalty. While some thinkers of the Left, notably Joseph Stiglitz (and to a lesser extent Rodrik and Subramanian referred to earlier) voice scepticism on the value of trade liberalisation, the brute reality remains that India's levels of trade taxation remain extremely high.

Continued waffling on this subject pretty much since the present finance minister was last in office, has surely been damaging to the investment climate.

Similarly the howls of protest in sectors such as tractors, computer hardware and textiles demonstrate the pitfalls involved in selective concessions to various groups, no matter how worthy. The transactions tax may be validated by its use in otherwise sensible countries such as France and Singapore, but that does not make it a good tax.

More broadly, the last Congress government exuded a sense of direction in tax policy, largely derived from the Chelliah report. That framework has increasingly eroded, and a new one urgently needs to take its place. The minister has signalled his concern with broad-gauged tax reform.

Let us hope that political circumstances will accord him the initiative seven months from now; otherwise this Budget will be seen as an important opportunity missed.

In sum, this Budget opens up important debates on the purposes and efficacy of public spending, while signalling the importance fiscal prudence. This is all to the good. What it lacks is a convincing story on the investment climate and the growth process. This is needed urgently, and not only via additional public investment.

Only with growth will this government's support base be placated. Spirited, coherent tax reform is a very good place to start. If the government takes up the challenge, India once again could become an intellectual role model for the developing world.

sbery@ncaer.org

(The writer is director-general, NCAER. The views expressed are personal)