Ashok Sanjay Guha
December 11
The heated debate on the National Rural Employment Guarantee Act focuses on two issues - the scale of leakages from the scheme and its financial cost and consequent contribution to the fiscal deficit. These are largely empirical questions of implementation - but any policy needs also to be considered in its idealized, perfectly implemented form so as to discern its inherent design and logic. Let us therefore assume zero leakages from the NREGA and negligible financial cost without any impact on the fiscal deficit. Suppose that every rupee spent on the scheme seeks out its target with infallible accuracy and is fully funded by a non-distortionary lump-sum tax.
Suppose also that the NREGA raises wages significantly - a result that is hailed by advocates of the scheme as its greatest triumph and one that is probably factually true. In the perfect world ruled by these assumptions, the NREGA would surely shine as the most resplendent accomplishment of the United Progressive Alliance, the most dazzling legacy of Sonia and Rahul Gandhi and the national advisory council?
Economics, unfortunately, is too complex for such grand simplifications. The NREGA assures every family anywhere in the Indian countryside of 100 days employment annually at or above minimum wages. It thereby erodes incentives for labour mobility from unproductive agricultural regions to higher productivity employment elsewhere. To each worker, the NREGA offers an opportunity for reasonable wages without migrating to an alien, possibly hostile, milieu, an increase in options that he often eagerly embraces. For him, this is a dominant strategy since he believes, correctly, that he personally can do nothing about the economic environment. But when millions of workers choose likewise, the economic environment is transformed: labour supply for the production of marketable goods dwindles, it 'tightens', in the words of the NREGA's passionate advocates, thus inducing the rise in wages that they celebrate. A possibly unintended - but inevitable - consequence of this 'tightening', however, is a sharp contraction of output, resulting in a powerful impetus to inflation even if the NREGA is fully tax-financed and therefore adds nothing to money income and demand. The NREGA, even a balanced-budget NREGA, imposes an inflation cost on the poor which may neutralize the benefit of the increased employment options that it offers. Since the rural worker was never offered the choice between price stability without the NREGA and inflation with it, one doesn't know what he would have preferred. The notion that the NREGA makes the rural poor better off is a classic example of the Keynesian 'fallacy of composition', the belief that what is true for the individual is necessarily true for the aggregate.
Here is the key to a mystery that many have found quite inexplicable - the secret of the UPA II's inflation. Indian inflation in the last two years so far outpaced global rates that it could not be blamed on external sources. And some have argued that the UPA was in fact a model of fiscal prudence compared to the National Democratic Alliance which somehow achieved price stability. Why then did prices rise significantly since 2008 and explosively in 2011-13?
The answer lies in the shortfall of output below its potential level due to the distortion of incentives induced by the NREGA and similar schemes. Inflation visibly accelerated since 2008, when the NREGA was rolled out nation-wide. It was driven by sky-rocketing food prices because, under the NREGA, both the injection of money income and demand and the withdrawal of labour supply were concentrated in agriculture.
The food price explosion paved the way for the Food Security Act. The poor had to be protected from the consequences of the NREGA by a government guarantee of virtually free food. This could not, of course, contain inflation. It merely deflected it away from cereals onto vegetables, fruit, pulses, oils, sugar, milk, other animal products and manufactures. The astronomical rise in these prices was a major factor in the UPA's electoral debacle.
Government commitment to free foodgrain supply affected production no less than consumption. It signalled to the farmer that the government has no option other than high cereal procurement prices and that he would find it profitable to divert acreage better suited to other crops to cereal cultivation. It led, therefore, to a loss of comparative advantage, a reduction in output due to a distortion in production incentives over and above the distortion of labour incentives directly caused by the NREGA, fuelling further inflation.
But what about the 'durable assets' the NREGA produced? Jairam Ramesh, the UPA's minister for rural development, confessed in December 2013 that the NREGA had failed to create such assets - a confession that surprised no one. The NREGA is obsessed with employment: it uses the most labour-intensive techniques, no machinery, only the most rudimentary tools, minimal energy and transport inputs and the cheapest locally available materials. Supervision concentrates on wage payment rather than creation of an end product. Projects are mostly never completed. When they are, they are washed away in the next monsoon and can be done all over again. The flimsiness of the NREGA's assets may not have mattered if they were the property of private farmers who would have an incentive to maintain them. Unfortunately, 89 per cent of these assets are public goods, common property that is therefore allowed to lapse into terminal decay almost as soon as it is created. All this is not a mere flaw in implementation: it is inherent in the objectives and design of the NREGA itself.
The NREGA visualizes creation by government on a vast scale and at the taxpayer's expense of 'disguised unemployment', the phenomenon of large numbers of people apparently working but adding little to aggregate output, perhaps even detracting from it. The Jamaican Nobel laureate, Arthur Lewis, described economic development essentially as this disguisedly unemployed rural labour turning into productive employment in manufacturing or capitalist agriculture - a definition accepted by generations of development economists. The NREGA seeks to reverse the Lewis process.
Inflation has eased in recent months. Does this signal the exhaustion of the inflation potential of the NREGA and the FSA? Not at all. Unlike the UPA's inflation, which was almost entirely 'made in India', the slowdown in inflation under Narendra Modi is an external effect: it reflects the world-wide collapse of oil and agricultural prices, the consequent recovery of the rupee and the resulting fall in import prices.
Our argument assumes that there are no leakages from the NREGA and its corollary, the FSA, and that neither adds a paisa to the fiscal deficit. These issues could easily be enmeshed in a web of 'lies, damned lies and statistics'. But the constraint on output due to a disincentive to effective work or to optimal use of land and the resulting continuous injection of inflation into the economy are indisputable.
Both schemes, of course, are electorally well-entrenched. The poor voter believes that they add to his welfare: their inevitably inflationary outcome is too remote to concern him, especially since it has eluded most economists. In the NREGA and the FSA, the UPA has erected two barriers to development under any subsequent regime. A government that repeals them will pay a heavy short-run price. But if it persists with them, it will generate long-run inflation. The UPA's experience is illustrative. The promise of the NREGA won the UPA the 2004 elections. The short-run benefits from its early days accounted for the 2009 result. But by 2014, the chickens had come home to roost. The 2014 election was a referendum on the long-run consequences of the NREGA (not, as the Aam Aadmi Party and the UPA learnt to their cost, on corruption or communalism) - and the electorate's verdict could not have been more devastating. If Modi does not phase out NREGA (and the FSA), he may avoid some short-run electoral reverses; but he will run the risk of repeating the UPA's dramatic reversal of fortune in the 2019 general election.
The author is Professor Emeritus, JNU
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