Saturday, July 21, 2012

Economics of Social Welfare

Creation of a welfare state has been one of the most cherished goal of societies and countries all over the world and through out our history. Yet, we have not succeeded in fully achieving this goal. The ways of ensuring social welfare to all have sparked many debates and cold wars through out history.

It is also at the heart of the 2013 American presidential election. While the democrats feel that more state involvement in health, education and infrastructure will ensure the welfare and well being of the citizens, the republicans reason that government action is inherently flawed and riddled with inefficiencies - so leaving more money with the people and corporations is the answer to greater prosperity for all.

In India, this debate has recently opened up with the work on Unique identity cards and plans for direct cash transfers to the citizens, instead of blanket subsidies. While the political discourse in India has always been for more Government action in areas of education, health and employment, thanks to the inefficient government and its colonial lineage- the government involvement in these areas is very little.

The core conflict in the issue of public welfare is that while free market is usually very efficient, it is ruthless. The incentives of corporations do not always align with the social goals a country wishes to achieve. On the other hand, though the government action is not driven by profit - it leads to a lot of inefficiencies. The defunct organizations,  failed ventures and outdated establishments -supported by the government -stay put on life support for too long further accentuating the problem. A case in point will be the notorious government primary education and primary health centers which are dreaded by the people and no one goes there by choice. 

The goal of providing all citizens with adequate food and nutrition in India is a good case in point to highlight the conflicting nature of the government and the market solution for it. To begin with, the government of India buys food grains from the farmers at a fixed price -Minimum Support Price (MSP)- that is decided once every year. This is done to make sure that the poor farmers earn enough to support themselves and to shield them from the fluctuations in the free market price. This also helps in making sure that farmers do stay in business, and there is no shortage of food. The government then hoards a lot of grains in dilapidated granaries (where the grains rot very often), as flooding the free market with all the produce will plummet the market price of grains. Thus the market price is artificially high, even though there is a bumper crop in the country. To make sure that all citizens are able to afford basic food  necessities - the government has a another network of Fair Price Shops (FPS), where the grains are sold at a discount. Needless to say that with a huge difference in the price at which the grain is sold in the free market and the FPS, there is a lot of corruption and a large portion of grains intended for the FPS is sold in the open market. This circuitous route to paradise leaves every one in misery. Further more, the political incentives ensure that the MSP is never lowered even though there is an excess of supply. Thus the farmers are incentivised to keep producing the same crop year after year in more quantity, even though it is not of much use in greater quantity. This ensures that farmers never move to production of other produce that is more in demand, like protein sources not supported by the government. This in turn creates a shortage of such products like milk and poultry-  raising the prices of such commodities - ensuring that there is a problem of chronic malnutrition in India.


Leaving it all in the hands of the free market is a dangerous solution too. Corporations are driven by profit and not social goals of eliminating hunger and malnutrition. If a cash crop fetches more price than  food grains, the free market will not blink twice before incentivising more farmers to switch to cash crops. This has already happened in the past during the British rule. The wealthy colonial planters would force the indentured farmers to grow more and more of indigo than food crops leading to acute shortage of food grains, even for the farmers. 

While we want the free market mechanism and market price to make sure that the incentives of the producers and consumers are in sync with the demand and supply of a particular good or commodity, we have to make sure that every person has adequate access to good food and nutrition. Neither government lead solution or the market mechanism alone can provide for it. We need a hybrid approach for it. One such approach is direct cash transfers from the government to the people. 

For the case of food production, the government should ensure that both the farmers and the consumers of food grain have some assured minimum income to support themselves. Any one not able to earn the bare minimum to pay for the cost of living should get cash from the government, as a negative tax (as proposed by Milton Friedman). The government should leave everything else to the free market. The price of the food grains, will be decided by the free market to make sure it matches the demand and supply for it. Since the cash transfer ensures that every one has enough money to support their bare minimum needs, the goal of providing food and nutrition to everyone will be fulfilled. Further the market will drive towards more cost effectiveness. The consumers  will switch to more nutritious and cheaper sources of nutrition. The farmers will switch to crops/ produce more in demand and higher in price, thus bringing down the price of the same. 

The same solution can be applied for education, health, electricity and other basic needs of individuals. Most people in India prefer private health care providers to the public ones. The private health care cost is much lower than its public counterpart, and it is much better in quality (search for Dr. Devi Shetty for more). While the doctors and administration in public hospitals keep following the old and ineffective practices, the private sector moves ahead with great agility. Those who don't, have to shut shop and new players come in. Similarly, private schools provide much better facilities and education to children than the notorious government schools which run at a much higher cost than the private schools. 
The case of providing affordable electricity to all in India demonstrates the harm caused by government  intervention at wrong places in the supply chain, and how it not only affects the price of electricity but also fuels more conflict in India. In pursuit of the goal of providing cheap electricity to the consumers, the government of India sells rights for mining coal to electricity companies at hugely subsidized rates. According to recent news reports, it is alleged that the Comptroller and Auditor General (CAG) of India has estimated that the government lost about 33 billion $ in revenue, by not selling the mining rights at market prices via an auction [1]. To put the number in perspective, the total revenue of the government of India in 2010 was about 185 billion dollars [2]. As expected this creates more problems for electricity generation. First, the artificially low rates of coal mining rights ensures that the power production in India is skewed towards coal plants. This creates more and more demand for coal which cannot be supported by current levels of production. Further, the new coal mines are deep in the forests inhabited by tribal people for ages. The mining companies moving in to mine the black gold destroy a lot of forest cover and displace tribal people. This leads to further conflicts and delays in the projects. This problem is also at the heart of the Maoist problem in India. The environment suffers at multiple levels due to this approach. First mining coal destroys forests and pollutes the environment. Second, burning coal to produce electricity produces a lot of ash and emissions - making India one of the big green house gas emitters in the world. The cost of production of electricity is heavily skewed because of this, hence the other sources of electricity like solar, wind and nuclear power do not get enough attention. Further artificially lowering the price of mining rights does not ensure more production of coal, as the ground realities do not alter by altering the price artificially- the price should rather reflect the ground realities (i.e. market set price).


Thus we have established, that the well intentioned government policy leads to more problems for production of electricity and hence causes shortage of same. Thus the market price of electricity is high due to high demand. Again the good government steps in and has created electricity boards which sell electricity to the people at subsidized rates, and charge higher rates from the industry. As a result most of the electricity boards are running a huge loss. This policy also ensures that the consumers keep increasing the use and waste of electricity. Thus demand keeps increasing. The consumers have little incentive to invest in more efficient electrical devices or solar panels when electricity is cheap. While this is true for the fortunate few who are supplied electricity for at least 16 hours a day, the rest of India remains in darkness and dependent on other sources for heat and lighting. Diesel generators for electricity generation are very common, and so is the use of LPG and kerosene for cooking and heating. Again the high demand of these goods means higher market price and that means more subsidies from the government for kerosene, LPG and diesel. 
Would not it be much simpler if the government provided enough cash to the people to ensure it covers the bare minim cost of living which includes cost of food, electricity, health and education, and removed subsidies/ government intervention at all other levels. The government action that would least disrupt the market mechanism for efficient use of resources is at the end of the supply chain i.e. the consumers. Just make sure that the consumers have enough money to cover the bare minimum costs of living, and watch the invisible hand of the market to provide for the rest in a more efficient and probably more environment friendly and humane way. It is important for the government to function at the edges of the supply chain and not within it. We need good regulators from the government to make sure the right of consumers, tribal people and others are protected, and the environment is not polluted. We need government to make sure everyone can afford basic amenities. We don't need government to meddle in the market mechanism for effective utilization of resources.

Saturday, February 4, 2012

Exploring an Idea - crowd sourcing activism: NGO 2.0

"For every beneficiary of a court order enforcing RTI, NREGA or RTE, the lawyer is entitled to a sum of money from the NGO. "

Priya is a hardworking 12 year old girl in a small village in central India. Her family lives below the poverty line. Yet she has a sparkle in her eye when asked about her future. She wants to grow up and become a reporter. She wants to spread awareness about the issues affecting her village and the surrounding ones. Priya walks 4 kilometers every day to her school in a neighboring village. The school has just one classroom, no toilets and student to teacher ratio is 1 to 60, that is if all the teachers show up on a day. It would be nice if Priya had a decent school in her village with proper classrooms, basic amenities, good teachers and low student to teacher ratio.

Raj is a 30 year old man in the same village. He is planning to migrate to Mumbai for the next 8 months, leaving his kids and family behind. He is a hardworking honest man and does his best to take care of his family. There is no work for him the village and hence he must stay away from his family for 8 months every year, living in a slum in Mumbai and earning his living. The village always has a shortage of water during the non monsoon season. This means a lot of agricultural activity grinds to a halt in that period pushing people out of the village in search for work. Digging a pond and harvesting the rain water would go a long way in solving the problem, but no one has the resources to undertake this project. There is little trade or other means of employment at the village even though it is close to a town with great demand for fresh produce. The reason behind this is that the village does not have a good road linking it to the town- making it hard to transport the produce. A road linking the village to the town would help but again there are no resources.

Just next door from Raj's house lives Radha - an 80 year old widow with no children to take care of her. The old lady lives in a decrepit house which provides little protection from rain or sun. She lives on the kindness of the villagers to have one meal a day. She is a perfect candidate for many government schemes - old age pension, below poverty line housing and health care, and food at discounted price from the public distribution system. Yet she gets none of it as the village official demands a cut in her benefits for certifying that she is old and below the poverty line.

What would be the best way to tackle all these problems at a scale of hundreds of millions and with limited resources?

Many people look for an out of state solution. This is born out of disgust for state's practices and neglect of the welfare of its citizens. Many people rather form Non Governmental Organizations (NGOs) to solve the problem with little help from the government. This works well for a village but never scales up to 6 million villages all over in India. The state regularly comes up with schemes and laws designed to solve the massive socio- economic problems of India - but the schemes which work perfectly on paper leave no mark on the ground. There has been a recent addition to the hundreds of tools for social and economic transformation of the country. Three major acts deserve mention here:

  • Right to Information Act (RTI) - it gives a citizen a right to any information (public or pertaining to the person) from any government office in a time bound manner. In case an officer does not furnish this information, the law prescribes action against the officer. 
  • National Rural Employment Guarantee Act (NREGA)- it gives any person in a village the right to employment in his/her village. The person must get work within 15 days after applying for it, else the person should receive an unemployment allowance. 
  • Right to Education Act (RTE)- it empowers every child in the nation to get quality education in his/her village or town. The state must provide for each child, a good school with proper amenities and ample number of qualified teachers. 
These three laws stand out from the rest of the efforts of the government to better the state of affairs in India. These laws give entitlements to the citizens which can be enforced by the courts. Yet the change has not taken place at a pace we would like. Very few of the affected have the necessary means to get their rights enforced in the courts. NGO's provide some help to a few - but they are out of step with the new opportunity. NGOs work on the same old model - having a small group of dedicated people working in a small area to improve conditions of a few people. Thus NGO's end up spending a lot of money with little impact. The answer to this problem lies in moving away from the model of tapping into the tiny pool of social workers and incentivize a much bigger, larger and more suitable pool of persons for the job - the lawyers. 

India has a large number of lawyers - too many compared to the demand. This demand-supply imbalance has created large pool of lawyers who are willing to work at lower wages. Only a few well acclaimed lawyers charge exorbitant fees - the average fee for lawyers is not too high. Many in this large pool of lawyers are capable of wielding the tools of social transformation given by the state to the citizens - all three acts stated above have redressal mechanisms simple enough that any educated person can use them (thus lawyer in this sense means any person with or without a law degree arguing for enforcement of these rights). All we need is an incentive:

"For every beneficiary of a court order enforcing RTI, NREGA or RTE, the lawyer is entitled to a sum of money from the NGO. "

This mechanism will help Priya become a reporter, Raj get an employment in his village, and Radha get her due. In addition this will help improve the infrastructure of the village in terms of roads, schools, ponds, etc., and also be a meaningful source of income for the hundreds of thousands of lawyers seeking work in a country full of violations of citizens' rights by the state. Since the payment is based on the end result- it ensures efficiency and makes sure only successful lawyers are paid. The large pool of lawyers will ensure that the sum paid to each lawyer per beneficiary will be small. The price paid to each lawyer can be decided in a fair manner by an auction or a market mechanism to ensure that the price paid is not too small that no one comes forward for the task, and is neither too high that the mechanism becomes inefficient.

This mechanism will ensure that the impact of  money spent by the NGO does not depend on the motivation and honesty of the few workers on the ground, and ensures a much wider impact for a smaller amount of money with much better accountability for each buck spent. 

Sunday, January 8, 2012

Inhuman economics and policy making

It is rather often that we miss the woods for the trees, but in the realm of policy making and economics, this more of a rule than exception. The development of nations is like a proverbial beast outside the city of blind men. The selected group of men from the city (read scholars of economics and policy making) visit the beast often and try their best to describe the beast in terms of tangible statistics. But alas the beast is much more.



It is almost impossible to accurately describe the ultimate economic goal of any nation or society in terms of tractable statistical variables. At a given point of time, we may be lucky to see the symptoms of the economics malaise in terms of GDP, but soon the goal of the treatment shifts to removal of the symptom and not the cause. This trend has carried on far to long in the present world, that while all the economic indicators may look great, the man on the street is not. The occupy movements in various parts of the developed world are an instance of that. We got too busy, looking at the GDP numbers that the distribution of wealth and the mobility of persons from the bottom of the economic stack to the top became worse. Now we can latch on to these parameters and then we shall soon find the goal slipping away through some other unforeseen parameter. 

While the goal of a society should be the development of it citizens, it has been replaced by the more tractable one - increase in GDP of the nation. At some point of time the two seemed synonymous but the correlation between the two has been getting weaker and weaker. Many nations with huge GDP suffer with low median incomes, and in some places it is not unusual to give a human sacrifice for the health of the national GDP (have a look at the arguments against even the basic social support services like health in US and food in India). Why is it that the complex notion of development of nation and its citizens has been reduced to a simplistic single number? It is a very dangerous mental block for all the policy makers. Whenever they sit and decide about the development of the society and the nation, they think not of the development as a whole and how to ameliorate the conditions of the citizens. They rather think how to make sure we get a better set of statistics the next time. It is like a student whose only motive is to get good grades and not to learn. The student may just rub off the grades put in by the teacher and forge new ones because what was once an indicator of progress has become the goal. 

While the numbers have taken precedence over humans in the way we see the development of a society, the holy grail of the policy makers has remained unchanged -  to build laws and institutions which shall be fail safe even when the most corrupt persons run the shop. This seems like a good idea, but it has made sure that the zero hypothesis of the policy makers is the every man is corrupt until proven otherwise. Thus we build the most cynical institutions and laws to govern our society. A doctor would rather let a patient die than take up the case and give his best, for the fear of malpractice suit designed to protect patients from clumsy doctors with evil motives. People would rather throw the left over food in the bins than feeding the homeless because the law protects us from all beings who would poison us or offer us rotten food.

We live in a grey world and the laws try to make things black and white for us. It works for the most part but there are still many grey areas where human beings suffer just because of the attempt to have everything in black and white. Informal economy is one of the grey areas that has been a source of relief and pain for many people. An informal economy runs outside the fence of rules and regulations set by the state. It may just be a person occupying the side walk to sell trinkets or some private car plying on the road as an informal taxi. This kind of activity causes a lot fuzziness in the world of formal economy. A driver running an informal taxi has an unfair advantage over the other taxi drivers as he does not pay any taxes nor need to follow any regulations. Similarly the person selling wares on the street usurps the public place and sets shop for no price at all. The response of the state in these cases has been to penalize such activities and prevent them from happening. This may seem all good but as the enforcement agencies get better and better at doing this, the hope for people who fell out of the rat race grows dimmer and dimmer.

The informal economy offers hope to a lot of people who live on the street and are without jobs. It is not only the source of some income for the people barely able to scrape by, but also a means to keep one occupied on the street and not to over obsess about the conditions which led them to the street. Informal economy is an important social safety net for the ones at the bottom of the hierarchy. It is also a stairway for many of them to come out of the situation they are in.

Informal economy must stay informal. Making the informal economy formal is not the solution. Take the example of slums- they are a form of informal urban housing for the poor. The slums are very effective in making sure that only the poor remain in the slums. This is done through the system of negative incentives. The conditions in the slums are bad enough that no one who can afford to leave them shall stay. The slums remain as illegal housing on city map. This ensures that many public amenities provided by the government are scarce in the slums. Also the question of ownership of the land remains unanswered. The ones who live in the slums do not own the land and the state often tries to remind the people of the fact by demolishing a part of the slums from time to time. Yet there are informal systems which ensure that you can leave your house in the morning and come back to the same spot in the evening. This system is usually enforced by corrupt officials who assign ad-hoc rights of property to the people or though a local strongman or group. Thus the slums are a permanent refuge of the destitute and the destitute only. The day the state grants slums a formal status and grants some kind of property right to the dwellers- the slum, as the refuge for poor, dies. The slum property becomes a fungible object that can be traded, inherited and improved upon by the occupant. Soon as all the public amenities follow with the granting of the formal status, the incentive to leave the slums without staking any claim goes down. Thus the slum which is a dynamic haven for the poor- a safe house for them in times of hardship- becomes a permanent settlement and the fresh batch of poor people find a new place which is further outside the fence of laws, public amenities and regulation as the boundary keeps expanding.

Conventional economics and modern law is unable to to handle to these situations as it breaks the binary nature of law and the goal of the policy makers to have institutions, free of the discretion of people, which are able to protect the citizens from the monster- a person will turn into if the laws are lax. But is it possible to develop economic theories which do not depend on numbers alone, but still be objective? Is it possible for policies to be framed which do no assume that every person is a terrible being unless proven otherwise, but still make them fail safe from the corrupt? Is it possible for the laws tolerate the grey area in society which may help bring people out of the dark, but still making sure that the whole world is not grey?