Real growth has steadily occurred because India has shared the world’s technological progress. But bad fiscal, monetary policies over decades have led to monetary weakness and capital flight
First published in The Sunday Statesman Editorial Page Special Article
January 20 2007
Anyone wishing to understand India’s macroeconomics today must seek to grasp how Government expenditure and taxing behaviour have become related over decades to Government’s rapid creation of paper-money and bank-deposits. Even those policy-makers who have caused this phenomenon (notably our present PM during his long career as the top economic bureaucrat, as well as his many acolytes and foreign and domestic flatterers) seem to have failed to grasp this. Thus they may be unlikely to identify let alone carry out the key political task facing India today, which is to transform the feeble existing state corroded by corruption and waste into a robust modern one with public institutions of a quality meeting or exceeding world standards.
Government expenditure in a democracy is supposed to be representative of real public needs. But democracy is everywhere imperfect, and spending tends to follow instead the pattern of special interest groups, i.e., who has how much organised lobbying power in the polity. “Whatever can be rescued from useless expenditure is urgently required for useful”, said JS Mill. How can public spending be made more productive (or less unproductive) by cutting waste, fraud and abuse, and instead better alleviate mass ignorance, poverty and destitution? And how can there be reduced chance of a collapse of confidence in public institutions, especially currency and the banks as has happened in other countries at different times? These are central questions for serious macroeconomic policy-making in India today. In fact, it is likely the Indian people are at present both over-taxed and under-taxed: we are over-taxed by the corroded, corrupt wasteful polity that has actually arisen, while we are under-taxed relative to the fiscal and monetary needs of a robust modern democratic polity yet to exist.
India has shared the technological progress the world economy witnessed in the 20th Century. Private ingenuity, enterprise and business acumen at all scales of operation are manifest in countless examples across the country every day. Real economic growth has taken place steadily as a result, and there is no doubt average levels of health, education, and material well-being have improved almost everywhere ~ often despite government action, sometimes thanks to it. Our legendary population has grown mainly due to lowering of mortality rates via better health, nutrition and awareness, causing longer life-spans than ever before. Our village festivals, market-towns and city-streets are filled with bustling shops with busy people and merchandise, while large concrete buildings are being built everywhere by invisible builders. There is no apparent lack of a potential basis for taxation of private resources for public uses in the country.
At the same time, monumental problems of absolute poverty, ignorance, destitution and inequality remain obvious to the naked eye everywhere in India, affecting hundreds of millions of citizens. A rare candid Government study said: “It does not require clever tools of measurement to demonstrate that there are millions of children in India who are totally deprived of any education worth the name. And it is not as if they are invisible, remote, and therefore unreached. They are everywhere in the cities: on the streets, wiping cars at traffic junctions, picking rags in mounds of waste; in the roadside eateries; in small factories, as cheap labour or domestic help; at ‘home’ completing household chores. In the villages again they are everywhere, responding to the contextual demands of family work as well as bonded labour.” (India Education Report, 2002, p. 47). Such and similar children, their parents and kith and kin constitute the hundreds of anonymous millions of India today.
Less than 30 million people are employed in the “organised” sector, about 18 by government and 12 by the “organised private sector”. Even if four dependents are assumed for each, that hardly makes 15% of the whole population of one billion people today. So while there may be some 150 million people in India who in one way or another engage with the “organised sector”, there may be 850 million who do not ~ reminiscent of Disraeli’s “Two Nations” of Dickensian England.
India’s tax-revenues are raised in proportion of about 30% direct to 70% indirect, where the same ratio for an advanced economy like the USA is about 90% direct to 10% indirect. A mere 10 million income-tax returns are received in a given year in all of India. The masses are being taxed, perhaps heavily, though they are mostly unaware of what is being indirectly extracted out of their household budgets through ubiquitous archaic systems of Customs and Excise. From long before the British arrived in India, there was a tax on salt via government monopoly, and long after MK Gandhi’s march to the Arabian Sea to produce salt freely, indirect taxes bear down invisibly upon the masses of democratic India today. Nicholas Kaldor approved the current system in 1956 but by 1959 had retracted and recommended widespread direct taxation instead, which has never happened. Kaldor’s best known Indian student is today PM of the country.
Also, everyone’s holdings of monetary assets in India have been taxed by inflation, without people realising it except for a continual feeling or memory of the dwindling value of the rupee and other paper assets. Government debt, the quantity of money and general price-level of real goods and services (the inverse of the price of money) have been on exponential growth paths, most conspicuously since the compulsory government take-over of banks in the early 1970s, though origins reach back to the start of pseudo-socialist “planning” in the 1950s (see graph).
When transparent visible taxation cannot be proposed and voted for in the “real” economy because it needs too much political effort or insight, governments resort to invisible, undemocratic means of taxing the public’s monetary resources by the subterfuge of inflating currency and bank deposits. Inflation has everywhere raised real resources for governments too weak to administer proper tax systems or resist the onslaught of organised pressure-groups in incurring public expenditure.
Taxation via inflation “does not require detailed legislation, and can be administered very simply. All that it requires is to spend newly created notes. The resulting inflation automatically imposes a tax on cash balances by depreciating the value of money” (Cagan). A routine means of meeting a government’s deficits can become “use of the printing press to manufacture legal tender paper money”, either directly by paying its creditors “with new paper money specially printed for the purpose”, or indirectly by paying its creditors “out of loans to itself from the Central Bank”, issuing money to that amount in exchange for government debt (Dalton). Because public memories are short and economic models and data unavailable to ordinary people, a large scope exists for governments to extract real resources by inflation before “money-illusion” comes to be dispelled. Briefly, such has been how India’s continuous budget-deficits have been financed ever since Independence – made possible with impunity because our rulers have also kept our currency from being internationally convertible (except for themselves).
These quite subtle facts remain practically unknown to the Indian public whose lives and those of future generations are deeply affected by them, though in recent decades elite elements like bureaucrats, academics, military officers, businessmen, politicians etc with better information and access to resources have sensed monetary weakness in the country and exported their adult children and savings abroad expeditiously. The sphere of knowledge and concerns of most people are so close to needs of their own survival that they make easy prey for the machinations of others with better information or access to resources. This may help explain why we, who for more than a century and a half have seen a vast political awakening take place and can take pride in having a free press and the world’s largest electorate, at the same time have had our political life and public institutions wracked by enormous corruption, fraud and venality, enfeebling the political economy by widespread cynicism and loss of confidence, and inducing capital flight abroad on the part of a vapid elite.
The weakness comes from basing economic policy and public welfare on ideas of demonstrable exility. The moral law may be a fine basis to live your life but hardly to run your country. Cheating your citizens is then only an easy next step, because it is all for a higher cause, much like religious charlatans, except that you hope to get the votes and subsequently the notes. You cannot give food security if you can’t pay for it, not can you provide a right to education when you haven’t a truant administration, not teachers not schools. Hypocrisy is embedded in the subcontinental mind. Making gestures is what Indian politics is all about as H Hatterr might have said.
What I have implicitly done in the article is describe what is known as the “Government Budget Constraint”, which has to be met by any government. Inflation as a means of making the government’s ends meet is quite standard practice (which may go to suggest dishonesty of course in all such governments).
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