Rising Government Spending In India: The Greatest Threat To Economic Freedom

Posted by patriotic_ayush in Business and Economy, Politics
January 8, 2018

To quote Milton Friedman – “Nobody spends somebody else’s money as wisely as he spends his own.”

This quote perfectly sums up the inefficiency of government spending. When you have money which you didn’t earn, and you then spend that money on others, it is bound to be ineffective.

An increase in government spending is actually a problem masquerading as a solution. But the sad irony in India is that it’s not just the Left and the liberals that support more government spending (and also seem to take moral superiority in redistributing somebody else’s wealth). The conservatives and the right wing parties, which have, at least, philosophically opposed higher spending, have also seemingly backed big-spending programs and the fiscal stimuli.

Forget the Left/Right binary – if you ask an average Indian what’s wrong with the government and its policies, a vast majority would probably say that the government is not spending enough (in some sectors which, they think, are crucial).

Often, an Indian’s solution to major problems is either to enact a new law or to increase government spending.  Of course, the bureaucrats’ love for spending isn’t a surprise at all. What could be a more effective way to fulfill their desire for power than handing out more money and authority to control the masses – in their hands?

The fact that the citizenry seems to be largely ignorant about government spending is the cherry on the cake for them. This reminds me of a dialogue from “Yes Minister”, that Sir Humphrey said to Hacker (the Minister) – “The public doesn’t know anything about wasting government money. We are the experts.”

The point to remember is that a compelling argument for tax cuts can only be made on the premise of a cut in government spending. A tax cut without a reduction in spending will only increase the debts of the government, which will eventually have to be liquidated through the taxpayer’s money only.

However, the very idea of a reduction in government spending seems to frighten a lot of people. They often ask who will build the roads and schools without the government’s help.

The pathetic state of public education in India (even after spending billions of dollars) and the benefits of efficiency and spontaneous order that can be achieved through private roads and highways need no introduction. Even for a moment, if you believe that the state has a kosher role in infrastructure development, education and health, there is still a vast area of government spending, which, in my opinion are a total waste.

To cite just a few examples:

1. The total government expenditure increased from ₹20,144 billion (for the financial year, 2016-17) to ₹21,467 billion (for the financial year 2017-18) – an increase of almost ₹1.32 trillion.

2. The government has allotted ₹480 billion to the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS), the highest-ever allocation to the scheme. A scheme that the PM had once called a ‘living monument of UPA’s failure’.

3. The subsidy bill also rose by 3% to ₹2.4 trillion.

4. The government is going to set up a dairy-processing fund of ₹80 billion over three years.

5. Instead of privatising the public banks, the government has infused ₹2.1 trillion in order to improve the health of public sector banks (PSBs).

6. Loan waivers worth ₹360 billion in Uttar Pradesh and ₹300 billion in Maharashtra are a few other examples.

7. As per a recent RTI, the central government has spent ₹37.5 billion on ads. Other governments seem to have been no different. The AAP government, for instance, had set aside ₹5.26 billion for publicity alone.

These are just a few examples of what, in my opinion, is a large-scale wastage of the taxpayer’s money.

Another area where the government spends people’s money recklessly is on various ministries which, in my opinion, shouldn’t exist in the first place. I don’t see what the need is to have a Ministry of Information and Broadcasting (I&B) in a free and democratic country like ours? But, instead of simply abolishing the ministry, it has been allocated ₹44 billion.

Is the sustained rise in government expenditure really as bright as it sounds? (Representative photo. Image source: Arun Jaitley/Facebook)

Similar arguments could be made for various other ministries, which seem to be of no use in the current setup. Also, the ministries with similar working and functions can simply be merged. Of course, this should be done after reducing their aggregate budget and employees by at least half.

Also. there are many government institutions and bodies on which a huge amount of money is being allocated. But, I do not think that they are providing any real value to the society. Arguably, these seem to be doing more harm than good for the country. In my opinion, the National Green Tribunal seems to be one such body.

Economic Arguments Against Government Spending

(Source: OCED)

The record, as the chart shows, is crystal clear – the size of the government has a negative correlation with economic growth. That means higher government spending reduces economic growth.

In fact, the US government’s spending as (% of GDP) was never more than 10% in the 19th and the early 20th century – arguably one of the most prosperous periods in human history.

The idea that more spending could be the cure for an economic slump was popularized by John Maynard Keynes, arguably the most famous economist of the 20th century. Keynes, in his book, “The General Theory of Employment, Interest and Money”, wrote:

“If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.

I have a hunch that those economists or bureaucrats who designed a scheme like the MNREGS (for which the govt. allocated ₹480 billion this financial year), must have read this extract before coming up with a program like that.

The above extract may sound a bit silly, but that is what precisely lies at the very heart of Keynesian economic philosophy which dominated the world in the mid 20th century, and partly continues to do so, even today. Keynes was admired by leaders across the political spectrum – and why wouldn’t he be? In my eyes, he propounded an economic framework which justified giving more power in the hands of politicians on the pretense of a ‘crisis’.

At a time when there seemed to be a general consensus among the Economists that governments should strive for balanced budgets, Keynes said that it was perfectly fine for the governments to spend more than the revenue they’ve collected. In fact, that is exactly the solution that he offered to overcome the crisis.

Much of the Keynesian philosophy (adopted in the US, during World War II) – that war spending actually drives the economy and reduces unemployment – is based on the ‘broken window fallacy’.  Also, digging holes and filling them may reduce unemployment, but it doesn’t provide any real value to the society. Besides, this doesn’t create any real growth, as real growth depends on fulfilling the demands of individual needs. Thus, according to me, nothing could be a better example of wastage of public money than this one.

The other reason the proponents cite in favour of more government spending is the effect of the ‘fiscal multiplier’. Fiscal multiplier refers to the ratio of increase in national income due to increase in government spending. For example, if the government spending is worth $1 billion generates a national income of, say, $1.5 billion, the fiscal multiplier is said to be 1.5.

Economists disagree on the extent of the impact of this multiplier on an economy. While the concept of the fiscal multiplier is very much fundamental to Keynesian economics, the Austrian school of economics rejects the idea of multiplier completely. Other economic schools lie somewhere in between these two extremes.

The impact of this multiplier was thoroughly debated after 2008-09 global crisis, when President Obama passed an order for the fiscal stimulus worth $787 billion. However, the impact of the fiscal multiplier could be better understood by some of conclusions drawn from a research paper by the International Monetary Fund (IMF), which was published in 2011, titled “How Big (Small?) are Fiscal Multipliers?

The following were the key conclusions:-

1.The long-run multiplier in high-income countries was 0.80. That means for every rupee that a government spent, only 80 paise worth of output was generated which means 1/5th of the amount was ‘crowded out.’ Whereas, the long run multiplier for developing countries was 0.18 which means more than 4/5th of the spending was crowded out.

2. The multiplier in countries with an open trade policy was negative and varied between -0.28 (in the short run) and -0.75 (in the long run). In countries with closed trade policies, however, the multiplier varied from 0.02 (in short run) to 1.29 (in the long run).

3. The multiplier for countries whose debt to GDP ratio is more than 60% (India’s debt to GDP ratio is currently 69%) was close to 0 (in the short run) and -2.3 (in the long run).

If one were to draw a conclusion from this IMF paper, it would be that the idea of fiscal multiplier and that economic growth can be driven through govt. spending is passe and seems to be simply untrue. The bureaucratic cost, corruption, and the ‘crowding out’ effect which could take place in any form (such as rising interest rates or inflation, etc.) are some of the reasons why higher government spending should be avoided.

Moral Arguments Against Government Spending

The pertinent question which everyone should ask themselves (before debating the morality of spending or taxation) is what, in their opinion, should ideally be the role of a government in a free society.

As far as I’m concerned, there is primarily a single duty of the state – to protect individual rights from ‘thugs’, that is, to have a strong national defense, a police force and a judiciary to enforce contracts – and to have common set of laws to preserve liberty and to safeguard the general public from third-party effects.

“Everyone wants to live at the expense of the State. They forget that the State lives at the expense of everyone.” – Frederic Bastiat

Narendra Modi and Arun Jaitley at an election rally in Delhi
Modi and Arun Jaitley may soon have a lot to answer for, if they keep being reckless with government expenditure.

Now, it is to be noted that a government ideally has no money of its own. Therefore, every rupee that the government spends is first being taken from someone else, even through coercion. Some people may say that government can spend by printing money. But that too is a form of tax called the ‘inflation tax’. The worst part of the inflation tax is that it is a regressive tax. To quote Friedman again, Inflation is taxation without legislation.”

So, every increase in government spending decreases household/private spending, savings and investment. In my eyes, spending an individual’s hard-earned money on government programmes isn’t just inefficient – it’s immoral too.

Also, the government borrowing the money to spend it on subsidies and other welfare programmes adds to the huge amount of debt. India’s public debt is near ₹70 trillion and the debt to GDP ratio is close to 70%. Eventually, these debts will have to be paid – either now or in the future. So, the careless spending by the state is creating a burden on the future generations. Don’t you think that’s immoral?

Thus, to me, the only effective mechanism to reduce public debt is to reduce government spending.

A lot of people voted for Modi thinking he would be India’s Reagan or Thatcher. But, if he is really serious about his fiscally-conservative credentials, then, he should strive for no other goal than a massive reduction in government spending.


Featured image used for representative purposes only.

Featured image source: Arun Jaitley/Facebook