Last week, the International Monetary Fund (IMF) released its latest Fiscal Monitor report, which discusses "fiscal policy in the great election year". A previous edition of the Fiscal Monitor had highlighted a significant policy 'trilemma' stemming from...
- Spending demands on national budgets due to wages, pensions, health care, industrial strategies, environmental concerns, defence, and Sustainable Development Goals;
- Widespread political reluctance to increase taxes;
- The imperative to manage debt and deficits to ensure fiscal stability and financial sustainability
Additionally, escalating interest rates and dimming medium-term growth forecasts complicate debt management. However, according to the IMF, this trilemma would exert a heavy influence globally as 88 countries go to polls this year. The IMF has warned against fiscal slippages this election year.
Tailored Policies
There is no dearth of evidence for such slippages. The Political Business Cycle Theory by William Nordhaus (1975) suggests that elected officials may manipulate economic policies to engineer favourable economic outcomes around election time. In particular, it posits that governments tend to increase public spending and cut taxes to boost economic activity and improve their electoral prospects, even if this may lead to larger deficits and greater long-term debt burdens.
However, India has diverged from this typical scenario in recent years. Instead of succumbing to the temptation of interim budgets that primarily focus on short-term gains and securing votes through new subsidies and other financial incentives, recent approaches by the Union government have prioritised long-term fiscal discipline over populist measures, highlighting a decade of economic stability and empowerment. This marks a departure from the predicted bias towards fiscal slippages in election years.
The concept of fiscal sustainability in welfare states hinges significantly on the notion of fiscal space, which Peter S. Heller defined as the ability of a government to allocate resources for specific goals without compromising on financial health. The challenge of securing such a fiscal space is multifaceted. It requires strategies to generate the necessary funds to meet social obligations while simultaneously ensuring that these financial mechanisms do not stifle economic growth or disrupt fiscal stability. Authors like Marcel (2014) and Harris (2013), along with Ortiz et al. in multiple works emphasise the balance required to manage welfare expenditures and revenue generation.
Questioning Fiscal Proposals Too
While there is a lot of literature on fiscal slippage before elections, there needs to be more focus on how fiscal sustainability is affected after elections when a new government is installed. Often, a new government may become fiscally imprudent in its quest to deliver on pre-poll promises, some of which might be financially ill-judged. Such promises often crowd out capital expenditure, which has a higher multiplier effect on the economy and people's overall well-being. One example of this is poll promises made by the current Karnataka government. Last February, an economic adviser to the state's chief minister claimed that "five poll guarantees is imposing a huge financial burden on the exchequer and exerting significant pressure on the state's economy".
This brings us to a wider debate on empowerment vs. freebies in social policy. While in some cases, cash and subsidies are necessary, political parties and governments should think more about empowering people rather than just doling out freebies.
Entitlement vs Empowerment
Instead of merely providing cash, empowering individuals through social policy can enhance personal agency and reduce the fiscal burden on government resources. There already is substantial theoretical and empirical evidence to support this. The argument draws on Amartya Sen's 'Capability Approach', which emphasises giving people the means to pursue their conception of a good life.
Esther Duflo and Abhijit Banerjee's work found that initiatives aimed at enhancing the skills and productive capabilities of the poor (like vocational training and microfinance) can lead to sustained economic improvements and reduced reliance on state-provided benefits. This further supports the case for promoting empowerment over entitlement.
The intersection of entitlement and empowerment is crucial for sustainable development. While entitlement lays the foundation by establishing legal rights and frameworks that recognise and protect women's rights, empowerment ensures that women have the practical means to utilise these rights to improve their lives and impact their communities. Duflo's research, for example, illustrates how this can bring about improved development outcomes.
The Perils Of Macroeconomic Instability
Freebies announced by several parties during the elections are expansionary. They might widen the fiscal deficit sharply. At the same time, they may hurt macroeconomic stability in the long run and affect private corporate capex recovery. Macroeconomic instability, marked by fluctuations in GDP, inflation rates and employment levels, directly impacts government budgets and expenditures. During economic downturns, reduced tax revenues and increased demand for welfare programmes can strain public finances, necessitating cuts in other areas or more borrowing. This financial pressure may lead to reduced investments in critical long-term social programmes such as education, healthcare, and social security.
Additionally, persistent instability often exacerbates income inequality, and those from lower socioeconomic backgrounds bear the brunt of economic downturns. This widening gap can compel policy adjustments to address disparities through measures like progressive taxation and targeted social assistance. It also necessitates policies aimed at promoting social cohesion and inclusive growth to maintain political and social stability.
Moreover, economic volatility complicates long-term planning and the implementation of social policies. This underlines the need for flexibility and resilience in policy frameworks. Health and educational outcomes can deteriorate during recessions due to reduced spending, and this calls for policies that can adapt and prioritise these sectors even during tough economic times. In the longer term, macroeconomic instability also affects demographic patterns and can influence birth rates and migration.
Balancing Short-Term Gains With Long-Term Feasibility
It's thus necessary to judge political parties not just on the promises they make but also on the fiscal plans they propose to service those promises sustainably. Political campaigns often feature a plethora of pledges designed to attract various voter groups. Yet, the feasibility of these promises needs to be addressed.
The true measure of responsible governance should be the ability of a party to articulate how it will balance short-term electoral incentives with the long-term fiscal health of the economy. This will encourage the evolution of a more informed electorate and promote policies that are not just appealing in the short run but also beneficial and sustainable in the long term.
(Bibek Debroy (@bibekdebroy) is Chairman, Economic Advisory Council to the Prime Minister. Aditya Sinha (@adityasinha004) is Officer on Special Duty, Research, Economic Advisory Council to the Prime Minister)
Disclaimer: These are the personal views of the authors