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 The defunct organizations,  failed ventures and outdated establishments -supported by the government -stay put on life support for too long further accentuating the problem.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.