The
process of economic liberalisation in India, as much as the economic repression
that preceded it has had economists in a leadership position in both the
formulation and implementation of the relevant policies. But the only one who
will live on as the architect of the Indian reforms is Manmohan Singh, and I am
delighted to be able to honour him on this occasion.
I. THE
NEXT STAGE OF INDIAN REFORMS
Even in the areas of past reform there is a great deal of unfinished business: notably to eliminate quotas on consumer good imports, and to move to full convertibility of the rupee by eliminating exchange controls. There are also whole areas which the reform effort has not yet touched. The common feature of this next phase of reform can be succinctly described as the rescinding of the unviable entitlements to income streams that past dirigisme has created. These have both deleterious macro and micro-economic effects.
On the
macroeconomic front, problems remain in removing the large budgetary subsidies
for fertilizers, energy, the public distribution system, and those implicit in
carrying loss-making public enterprises and redundant labour in the central and
state bureaucracies and parastatals. On the micro-economic side, India's 19th
century labour laws have hobbled Indian industry for much of this century (see
Lal(1988)). They need to be reformed if not repealed. Without the reform of the
labour market, the essential privatisation of the inefficient and still
substantial public sector is well-nigh impossible. Moreover, in the growing
global competition for footloose direct foreign investment, these antiquated
labour laws pose a serious disincentive for investors in India, when compared
with the defacto privatised labour market that now exists in East Asia, most
notably in southern China.
These
labour market reforms, and the rescinding of other unviable entitlements
created by past public interventions is resisted on the grounds that they would
worsen either the distribution of income or increase poverty. There is
sufficient evidence (see Bhagwati, Lal (1988)) that these claims are unfounded.
Most of these entitlements have done little to improve income distribution or
to alleviate poverty, their most discernible effect is to impair economic
efficiency and to corrupt the polity. But precisely for this last reason,
politicians will be wary of rescinding them for fear of losing support. Thence,
the politically convenient slogan "adjustment with a human face".
II. EGALITARIANISM
VS POVERTY ALLEVIATION
To
make sense of this slogan it is first important to note an important difference
between improving the distribution of income (an aim favoured by egalitarians)
and alleviating poverty (one favoured by most other people). A theoretical case
for a link between the two was made on the basis of the so-called Kuznets
curve- on which more below. But even if valid, this case for improving income
distribution would be as an instrument in alleviating poverty and not to
promote equality per se. Hopefully after the events of 1989, socialists of
various hue in India are at least chastened about the feasibility of
promoting egalitarianism, even if they think it is still desirable.
Without
entering into the sterile debates about the morality of egalitarianism, and
those to reconcile so-called "positive" and "negative"
freedom, all we need note is that, the egalitarians have now retreated to a
position where they claim that, the establishment of full-fledged Western style
welfare states in the Third World is required to alleviate its poverty. This is
particularly ironical given that the Western welfare state is everywhere on the
defensive if not in retreat. It is this contemporary socialist mutation which
is now increasingly identified with the term: blank (fill in any economic
policy you like) "with a human face".
But is
this "social democratic" case for dirigisme any more valid than the
old socialist one for planning, and will an acceleration of India's reforms
require the simultaneous creation of a Western type welfare state to alleviate
poverty? That is the central question I wish to address.
III. THREE
TYPES OF POVERTY
In
answering it, there are two distinctions worth noting. The first is
between extensive and intensive growth. Extensive growth
has occurred for millennia in most parts of the world with aggregate output
rising, pari passu, with the expansion of population that has taken
place since our ancestors came down from the trees. Per capita income was
however relatively low and stagnant during this phase. By contrast the modern
era has been marked by intensive growth with a secular rise in per
capita incomes as the growth of output outstripped that of population. There
has been a two centuries dispute whether such rises in per capita income will
alleviate poverty, that is whether the fruits of intensive growth will
"trickle down" and alleviate poverty?
Answering
this question is my first task. In doing so it is useful to distinguish between
three types of poverty, based on their causes. These are:
(i) mass structural poverty,
(ii) destitution
(iii) conjunctural poverty.
It is worth noting that though this distinction was well known in the past- for instance in discussions in England since the Elizabethan Poor Law- one strategic linguistic move by socialists was to conflate all of them, so that, structural poverty- about which nothing could be done until the era of modern growth- was conflated with destitution - for whose relief most societies have adopted remedial measures. A similar confusion for instance surrounds the whole recent discussion by a distinguished NRI theorist of what he calls An Enquiry into Well-Being and Destitution (Dasgupta (1993). What he is discussing is mass structural poverty reflected for instance in malnutrition and ill health, which though ubiquitous in the past - and more widespread than it need be in India today- is different from true destitution.
(i) mass structural poverty,
(ii) destitution
(iii) conjunctural poverty.
It is worth noting that though this distinction was well known in the past- for instance in discussions in England since the Elizabethan Poor Law- one strategic linguistic move by socialists was to conflate all of them, so that, structural poverty- about which nothing could be done until the era of modern growth- was conflated with destitution - for whose relief most societies have adopted remedial measures. A similar confusion for instance surrounds the whole recent discussion by a distinguished NRI theorist of what he calls An Enquiry into Well-Being and Destitution (Dasgupta (1993). What he is discussing is mass structural poverty reflected for instance in malnutrition and ill health, which though ubiquitous in the past - and more widespread than it need be in India today- is different from true destitution.
(i) Mass
Structural Poverty
Mass
structural poverty has for most of history been mankind's natural state. For,
till recently, most economies were agricultural economies, or what the economic
historian E.A. Wrigley has called "organic" economies, whose growth was
ultimately bounded by the productivity of land. In such an economy there is a
universal dependence on organic raw materials for food, clothing, housing and
fuel. Their supply is in the long run inevitably constrained by the fixed
factor -- land. This was also true of traditional industry and transportation
-- depending on animal muscle for mechanical energy, and upon charcoal (a
vegetable substance) for smelting and working crude ores and providing heat.
Thus in an organic economy once the land frontier has been reached, diminishing
returns will take their inexorable toll. With diminishing returns to land,
conjoined to the Malthusian principle of population, a long run stationary
state where the mass of people languished at a subsistence standard of living
seemed inevitable. No wonder the classical economists were so gloomy.
Even
in an organic economy there was some hope for intensive growth. The system of
market "capitalism" and free trade outlined and defended by Adam
Smith could increase the productivity of an organic economy somewhat from what
it was under mercantilism, which together with the lowering of the cost of the
consumption bundle, would lead to a rise in per capita income. But, if this
growth in popular opulence led to excessive breeding, the land constraint would
inexorably lead back to subsistence wages. Technical progress could hold the
stationary state at bay, but the land constraint would ultimately bite.
The
Industrial Revolution led to the substitution of this organic economy by a
mineral based energy economy. Intensive growth now became possible, as the land
constraint on the raw materials required for raising aggregate output was
removed. In particular, coal, which began to provide most of the heat energy of
industry, and with the development of the steam engine, virtually unlimited
supplies of mechanical energy. Thus the Industrial Revolution in England was
based on two forms of "capitalism", one institutional, namely that
defended by Adam Smith -- because of its productivity enhancing effects, even
in an organic economy -- and the other physical: the capital stock of stored
energy represented by the fossil fuels which offered mankind the prospect of
eliminating mass structural poverty for the first time in its history. It is
possible, as many countries in East Asia for instance have shown, to eradicate
mass poverty within a generation, because neither of the twin foundations of
the gloomy classical prognostications, diminishing returns, nor the Malthusian
principle are any longer secure. A market based liberal economic order which
promotes labor intensive growth can cure the age long problem of structural
mass poverty.
A
crude measure of the extent of mass structural poverty is the so called,
"headcount index" of the proportion of the population below some
national but time invariant real poverty line. Using this measure the Lal-Myint
country authors found that there was a clear positive effect of per capita
income growth on mass poverty redressal in all their countries over the period
of study 1950-85. Whilst Gary Fields (1991)- for the same study - found for a
larger sample that, in most but not all cases poverty tends to decrease with
growth, and that poverty tends to decrease most the more rapid is economic
growth.
For
India, Tendulkar and Jain (1995) have recently examined the effects of growth
on poverty alleviation- taking account of alternative social welfare orderings-
for the period 1970-71 to 1988-89. As they conclude "in comparison to the
1970s, the doubling of annual growth rate of per capita GDP in the 1980s was
associated with improvement in both the poverty and social welfare
situation" (p.40). In India as elsewhere growth thus does alleviate
mass structural poverty. In his famous "tryst with destiny" speech on
India's independence Nehru had stated: "the ambition of the greatest man
of our generation has been to wipe every tear from every eye". But the
policies he followed made this impossible because they damaged growth
performance. Even the slowly rolling retreat from this past dirigisme has led
to higher growth rates and in consonance with all the international evidence,
to some sustainable alleviation of Indian mass poverty. If only India could
sustain the spectacular growth rates that East Asia now has shown can be attained
even by large economies like China, it is indubitable that mass structural
poverty could be eliminated in India within a generation. That is the prize on
offer. Nothing stands in the way but political impediments that irrational past
dirigisme itself has created.
(ii) Destitution
With
mass structural poverty ubiquitous till recently, the problem of
"poverty" has historically been confined to destitution. Most of
these traditional organic economies were labor scarce and land abundant. The
destitute lacked labor power to work the land because they were physically
disabled and had no families. This remains a major source of destitution in
land-abundant parts of Africa.
With
population expansion and the emergence of land scarce economies in Europe and
in many parts of Asia, there arose "the poverty of the able- bodied who
lacked land, work, or wages adequate to support the dependents who were partly
responsible for their poverty" (Iliffe, p. 5). Their poverty merges with
mass structural poverty and growth will, as it has, lead to its amelioration.
No
estimates of destitution in India- as far as I know- are currently available.
Michael Lipton's attempts to find some correlates of destitution, based on
village studies, however, show the extremely heterogenous composition of this
group. Thus, for instance Dasgupta's seemingly reasonable assertion that widows
are "routinely forced into destitution" in India (p. 323) has been
shown to be false by Dreze and Srinivasan (1995) who find "in terms of
standard poverty indices based on household per-capita expenditure, there is no
evidence of widows being disproportionately concentrated in poor households, or
of female -headed households being poorer than male headed households".
(iii) Conjunctural
Poverty
This
leaves conjunctural poverty. In organic agrarian economies, climatic crises or
political turmoil are its main cause. Its most dramatic manifestation is a
famine. Since the Indian Famine Code was devised by the British Raj in the late
19th century, it has been known that to deal with what Sen (1982) labels the
"entitlement failures" precipitating a famine, the government should
provide income directly (through public works or food for work schemes ) to
those suffering a temporary loss of income generating employment. This
administrative solution has eliminated famines in India.
Finally,
the Industrial Revolution has introduced its own source of conjunctural poverty
in the form of the trade cycle and the unemployment that ensues in its
downturns. But in India's primarily agrarian economy, the seasonal unemployment
of landless labor in rural areas is likely to be of greater importance than
urban industrial unemployment. Rural public works schemes like the Maharashtra
Employment Guarantee scheme (see Ravallion (1991)), have been effective both in
preventing famines and in dealing with problems of short run income
variability. But their success lies in the self-targeting that is made possible
by offering a wage that only the truly needy will accept.
(iv) Income
Transfers and Poverty Alleviation
Income
transfers are the only way to tackle destitution and conjunctural poverty.
Traditionally these have been provided by private agencies -- the church,
private charity, and most important of all, transfers within extended families.
These
private transfers were however replaced in most Western societies by public
transfers through the Welfare State. In assessing the case for Western style
welfare states in dealing with the continuing problems of destitution and
conjunctural poverty, it is useful to first distinguish between social
safety nets and welfare states.
The
distinction between the "welfare state" and a "social safety
net" essentially turns upon the universality of coverage of transfers
under a welfare state as opposed to the restriction of collectively provided
benefits under a social safety net to the truly needy. The World Bank's, Poverty
Reduction Handbook, [PH] noted two essential elements in any design of a
social safety net: "identifying the groups in need of assistance, and the
means of targeting assistance to those groups cost-effectively." It went
onto ask: "Are these questions for public policy, or are they adequately
addressed by the traditional family network?" ([PH], pp. 2-13)
By
contrast, welfare state advocates favor universality as it alone in their view
provides a feasible means to achieve the ends sought to be subserved by a
social safety net, because of problems concerned with obtaining the requisite
information for targeting. Some have argued that, because of the ubiquitousness
of imperfect information, markets for risk will be inherently imperfect. Hence,
universal welfare states are required as part of an efficient solution to deal
with "market failure". To deal with this argument would take me too
far afield. Suffice it to say that this is a form of "nirvana
economics" -- currently fashionable on the left -- but it provides no
credible justification for a welfare state.
IV. TWO
RIVAL PHILOSOPHIES
An
implicit objective of those who argue against targeting and in favor of
universal welfare states is distributivist. To judge its validity it is useful
to contrast two rival ethical and political traditions: the classical
liberal and the distributivist egalitarian, which continue to
jostle for our attention and color the various policies offered for alleviating
poverty.
(i) Classical
Liberalism
For
the classical liberal it is a contingent fact that there is no universal
consensus on what a "just" or "fair" income distribution
should be, despite the gallons of ink spilt by moral philosophers on trying to
justify their particular prejudices as the dictates of Reason. Egalitarianism
is therefore to be rejected as the norm for deriving principles of public
policy.
This
does not mean that classical liberals are immoral! The greatest of them all
Adam Smith after all wrote The Moral Sentiments. Both of the great
moral philosophers of the Scottish Enlightenment- Smith and Hume- recognized
benevolence as the primary virtue, but they also noted its scarcity. However,
as Smith's other great work The Wealth of Nations showed,
fortunately, a market economy which promotes "opulence" does not
depend on this virtue for its functioning. It only requires a vast number of
people to deal and live together even if they have no personal relationships,
as long as they do not violate the "laws of justice". The resulting
commercial society promotes some virtues - hard work, prudence, thrift and
self-reliance -- which as they benefit the agent rather than others are
inferior to altruism. But, by promoting general prosperity, these lower level
virtues do unintentionally help others. Hence, the resulting society is neither
immoral or amoral.
A good
government, for the classical liberal, is one which promotes opulence through
promoting natural liberty by establishing laws of justice which guarantee free
exchange and peaceful competition. The improvement of morality being left to
non-governmental institutions.
But
from Smith, to Friedman and Hayek, classical liberals have also recognized that
society or the State should seek to alleviate absolute poverty. On the
classical liberal view, as my colleague Al Harberger has noted, there could be
an externality, whereby "the [poor] recipient's consumption of particular
goods or services (food, education, medical care,housing) or his attainment of
certain states (being better nourished, better educated, healthier, better
housed) that are closely correlated with an 'adequate consumption of such
goods" enters the donor's utility function. As it is the specific consumption
of these commodities, not the recipient's "utility" which enters the
donor's utility function, there is no "utility" handle which can be
used as on the alternative distributivist view to allow distributional
considerations to be smuggled into the analysis of poverty alleviation
programs.
Thus
the indigent and the disabled are to be helped through targeted benefits. For
various merit goods-health, education and possibly housing -- these involve
in-kind transfers. This is very much the type of social policy package that was
implemented in Pinochet's Chile, and which succeeded not only in protecting the
poor during Chile's arduous transformation to a liberal market economy, but
also led to dramatic long-term improvements in its various social indicators.
(ii) Distributivist
Egalitarianism
The
alternative technocratic approach to poverty alleviation is by contrast
necessarily infected with egalitarianism because of its lineage. At its most
elaborate it is based on some Bergson-Samuelson type social welfare function,
laid down by Platonic Guardians. Given the ubiquitous assumption of diminishing
marginal utility underlying the approach, any normative utility weighting of
the incomes of different persons or households leads naturally to some form of
egalitarianism. But this smuggling in of an ethical norm which is by no means
universally accepted leads to a form of "mathematical politics".
Poverty alleviation becomes just one component of the general problem of
maximizing social welfare, where given the distributional weighting schema, all
the relevant tradeoffs between efficiency and equity, including intertemporal
ones can be derived in terms of the appropriate distribution cum efficiency
shadow prices. If the concern is solely with those falling below some normative
"poverty line", this merely implies a different set of weights with
the weight of unity say to changes in consumption (income) above the line, and
increasing weights to those who fall progressively below the poverty line.
But
this is a thin edge of a very big wedge, as far as the defenders of the market
economy are concerned. Besides leading to recommendations for all sorts of
redistributive schemes, it also leads to a vast increase in dirigisme. To
alleviate poverty, an end embraced by classical liberals, they are on this
route being led to endorse the creation of a vast Transfer State, which in the
long run is incompatible with the preservation of a market economy.
A
usual riposte to the classical liberal position of separating questions of alleviating
absolute poverty from inequality is that, in theory, a market based growth
process could lead to such a worsening of the income distribution, that instead
of the poor seeing a rise in their incomes as part of the growth process, they
could be immisserized. This view was strengthened by the so-called Kuznets
hypothesis which stated that, inequality was likely to worsen in the early
stages of development before it
declined,
as per capita incomes rose towards current developed country levels. All the
empirical evidence, to date, is against the Kuznets hypothesis, and its
corollary that growth might not alleviate absolute mass poverty.
V. PUBLIC
VERSUS PRIVATE TRANSFERS
Are
public transfers needed -- as the welfare state advocates claim to deal with
destitution and conjunctural poverty, and as some assert even to deal with mass
structural poverty. We need to briefly examine the relative efficacy of private
versus public income transfers.
(i) Private
Transfers: Kin based transfers, reciprocity arrangements and interlinked
factor market contracts have been the major way that traditional societies have
dealt with income risk. They have been fairly effective. With the inevitable
erosion of village communities it is feared that these private insurance
arrangements will break down and that no private alternative will be available
to counter destitution and conjunctural poverty in increasingly atomistic
industrial economies.
It is
in this context that the role of private inter-household transfers is of great
importance. Cox and Jimenez (1990) provide evidence to show that they are of
considerable quantitative importance. For example, among a sample
of urban poor in El Salvador, 33% reported having received private transfers,
and income form private transfers accounted for 39% of total income among
recipients. Ninety-three percent of a rural south Indian sample received
transfers from other households. In Malaysia, private transfers accounted for
almost half the income of the poorest households. Nearly three quarters of
rural households in Java, Indonesia, gave private transfers to other
households. About half of a sample of Filipino households received private cash
transfers. (p. 206)
Moreover
since the oil price rise of the early 1970s the poor in South Asia and parts of
Southeast Asia have found remunerative employment in the newly rich oil states
and their remittances to their Third World relatives has helped to alleviate
their poverty.
Private
transfers have by now been largely "crowded out" by public transfers
in the West. The potential for such "crowding out" in developing
countries has been estimated for Peru, and the Philippines by Cox and Jimenez
(1992, 1993). There is potentially a large "crowding out" effect if
public transfer systems were to be instituted in these countries. For example
for the Philippines they find that, if a public transfer program was instituted
which gave
each
household the difference between its actual income and poverty line income,
after private transfers adjust, 46% of urban and 94% of rural households below
the poverty line before the program began would remain below the line after it
was implemented!
Moreover,
the evidence suggests that private transfers are efficient. By relying on
locally held information, and on extra economic motivations like trust and
altruism, private transfers overcome many of the problems of adverse selection,
moral hazard etc., which have so exercised the "nirvana" economics
'market-failure' school. For as Cox and Jimenez summarizing the empirical
evidence conclude: "private transfers equalize income; private transfers
are directed toward the poor, the young, the old, women, the disabled and the
unemployed" (p. 216).
(ii) Public
Transfers: Perhaps public transfers can do even better, so that we should
not worry if they crowd out private transfers? Public subsidization of the two
merit goods -- health and education -- are the major public transfers in nearly
all developing countries. In addition social security is important in many
Latin American countries.
One
question on which there is some empirical evidence is the incidence of the
benefits from subsidies for merit goods. This overwhelmingly suggests that
their incidence is generally regressive, and that they are very imperfect means
of helping the poor.
A
revealing piece of evidence suggesting that public transfers not only are more
inefficient in poverty redressal than private transfers but also crowd them out
is provided by a 1990 World Bank study. This traced public social sector
expenditures for nine Latin American countries in the 1980s ... [and] found
that real per capita public social spending on health, education, and social
security fell during some part of the 1980s in every country in the study. The
share of health and education expenditures in total government expenditures
also fell, even as that of social security rose. In spite of lower funding, and
no apparent increases in equity and efficiency, social indicators generally
improved in the 1980s.
(Grosh
(PH Box 3.4))
Apart
from obvious statistical and other biases which might explain this anomaly, the
most plausible explanation provided is that, it might be due to "the
growing role of non-governmental organizations, and the response of the market
oriented private sector to enhanced expectations and demand". That is
there was probably a "crowding in" of more equitable and more
efficient private transfers to replace the decline in public ones.
(iii) Political
Economy of Transfer States
The
"middle class capture" of the benefits of social expenditure is not
confined to developing countries. It has also been documented for the welfare
states of the OECD. A systemic process is clearly at work. It is the political
economy of redistribution in majoritarian democracies. In a two party system,
politicians will bid for votes by offering transfers of income from some
sections of the populace at the expense of others. Models of this political
process (which do not need to assume a democracy, but rather the interplay of
different pressure/interest groups) show that there will be a tendency for
income to be transferred from both the rich and the poor to the middle classes
-- the so-called "median voter". Even if social expenditures are
initially intended to benefit only the needy, in democracies such programs have
inevitably been "universalized" through the political process,
leading to what are properly called transfer rather than welfare states, which
primarily benefit the middle classes.
The
poverty alleviation that may occur as a by product of the expansion of the
transfer state is moreover bought at a rising dynamic cost. With the
universalization of various welfare schemes, political entitlements are created
whose fiscal burden is governed more by demography than the conjunctural state
of the economy. With the costs of entitlements rising faster than the revenues
needed to finance them, the transfer state, sooner or later, finds itself in a
fiscal crisis. This process is discernible both in developing and developed
countries.
For
developing countries the Lal-Myint study shows how this process is clearly
visible in those countries in our sample (Uruguay, Costa Rica, Sri Lanka, and
Jamaica) that under the factional pressures of majoritarian democracies have
created and expanded welfare states. All four welfare states were financed by
taxing the rents from their major primary products. With the expansion of
revenues during upturns in the primary product cycle, political pressures led
to their commitment to entitlements, which could not be repudiated when
revenues fell during the downturn in the price cycle. The ensuing increase in
the tax burden on the productive primary sector (to close the fiscal gap) led
to a retardation of its growth and productivity, and in some cases to the
"killing of the goose that laid the golden egg". Thus whilst there
was undoubtedly some poverty redressal as a result of the expansion of these
welfare states, over the long run these entitlements damaged the economic
growth on which they were predicated, and hence eventually became
unsustainable. Similar processes leading to the fiscal crisis of the state are
to be found in many other developing countries. Not surprisingly, many of these
countries with over extended welfare states are now seeking to rein them back.
Very
similar problems are also visible in the more mature welfare states of the
OECD. In some countries which had gone furthest down the public welfare route,
the late 1980s and 1990s saw a growing questioning of the welfare state in the
West, and in some cases its partial or virtual dismantling.
VI. POLICY
IMPLICATIONS
What
are the conclusions for policy which follow from this discussion.
The first is
that nothing should be done to damage the existing private institutions and
channels providing private transfers. "Forbear" should be the
watchword for every proposed scheme which seeks to alleviate poverty through
public transfers.
The second is
that, if for whatever reason, public money is sought to be transferred to the
"needy", this is best done through private agencies. Particularly for
the "merit goods" -- primary health care and primary education --
even if there is a case for public financing there is none for public production.
The third,
is that the very problems of moral hazard, adverse selection and monitoring
cited by "nirvana economics" as requiring public insurance, in fact
argue for fostering the alternative private route which capitalizes on the
comparative informational advantage of private agents with local knowledge.
These private welfare channels can be promoted by various methods of
co-financing them with public funds.
A
radical proposal maybe worth considering. This would channel all foreign aid
and domestic public expenditure on social programs and on "safety
nets" to alleviate destitution and conjunctural poverty through NGOS
(national and international charities). But to avoid the crowding out of
private by public transfers this public funding should only be provided on a
matching basis. The only reservation I would have about such a scheme is the
continuing economic illiteracy shown by so many NGOs's .
Finally, there is the
important question of severance payments that will be needed to slim the over
extended and inefficient public sector as well as the bureaucracies which were
set upto
manage controlled economies and are redundant with the move from the plan to
the market. Such structural adjustment faces political resistance from the
public sector workers who face retrenchment and/or cuts in their real wages.
Such workers can exert political pressure to prevent the rescinding of their
politically determined entitlements to future income streams which are above
what they would be able to obtain in the free market. The capitalised value of
the difference between their expected public sector earnings (including pension
and other benefits), and those they could get in the private sector (adjusted
for the probabilities of being hired and fired in the market), represent the
rents, public sector workers are currently receiving. If their resistance is to
be overcome they might need to be compensated for these rents. This is a
political rather than an economic argument for severance payments, over and
above those that might already exist in the contractual arrangements that maybe
in force in the respective labor markets .Given
the heterogeneity of the labor force, the rents derived from public sector jobs
will differ for different workers, being highest for the "bad"
workers whose market opportunities relative to their entitlements in the public
sector are the worst. With imperfect knowledge of each worker's rents, and the
difficulty in devising perfectly discriminating severance payment schemes, if
the severance compensation is set to persuade the last "bad" worker
to leave the public sector, the intra marginal workers will be receiving more
compensation than the capitalised value of their public sector rents. This
could mean a very high cost to the fisc. But in some cases (e.g., where the
public enterprise is producing negative value added at world prices), shutting
down the enterprise even with this high cost may lead to a gain in net GDP. In
others where the enterprise might still be viable after restructuring and
privatization, which involves retrenchment, the problem oftailoring
a severance package remains.The
most attractive plan which would meet both the objectives of limiting political
opposition and reducing the fiscal burden would be one limited to workers not
hired by the newly privatized enterprise. This tackles the adverse selection
problem whereby the "good" workers take the severance package and the
"lemons" are left with the new firm. The severance package for those
made redundant should be based on the principle of tailoring the benefits to
the median redundant worker's public sector rents. This would imply that, if
the severance package offered uniform compensation at the level of the rents to
the median retrenched worker, all those with lower rents would be better off,
and they would provide the political support for the scheme to override those workers
whose rents were greater than the median and would be worse off. Little more
can be said in principle about the specific terms of these programs which need
to be tailored to local conditions, and in particular the relative bargaining
power of public sector workers vis a vis the state.
CONCLUSION
Our
conclusions can be brief. There is no case for attempting to institute a
Western style welfare state in India. There are feasible ways of dealing with
the inevitable pain that the necessary reform of India's labour market will
involve. But it is going to require political courage. Lacking that, only a
fiscal crisis- which spills over into an inflationary and balance of payments
crisis- of the kind that led to the partial reform of India
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