Poverty & Inequality

NYAY e-Symposium: The potential macroeconomic impact of NYAY

  • Blog Post Date 02 May, 2019
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Niranjan Rajadhyaksha (Research Director and Senior Fellow at IDFC Institute) contends that the estimated cost of NYAY is substantial and there is ample reason to worry about the fiscal burden of the scheme. Further, the cash infusion in the economy may lead to inflation in the middle term and hence, the real income benefits of the transfer would be reduced.


Q: Do you have any concerns about the fiscal burden of the extra expenditure associated with NYAY? Do you think that the existing tax rates would have to be changed or the existing subsidies eliminated to accommodate the scheme? 

The estimated cost of NYAY is substantial – Rs. 3.6 trillion a year. It would be broadly six times what has been allocated to MNREGA (Mahatma Gandhi National Rural Employment Guarantee Act) in the interim budget presented in February 2019. It is also nearly 13% of total central government expenditure for the fiscal year 2020. It is hard to see how such a large incremental spending programme can be funded through cuts in other expenditure items alone, including non-merit subsidies. That will be a very difficult political economy call, given that non-merit subsidies mostly benefit vocal interest groups. There thus has to be either fiscal expansion or an increase in tax collections. The latter could – but need not – entail higher tax rates. India could be at an inflection point at which its tax-GDP (gross domestic product) ratio begins to grow rapidly, but that is a guess rather than a hard fact. In short, there is ample reason to worry about the fiscal burden of NYAY. 

Q: What would you say to people who are worried that an infusion of cash would increase demand but not the supply and cause a price rise? 

The inflation risk cannot be dismissed. There should ideally be no impact on the general price level if NYAY is fiscally neutral, since aggregate demand does not change. But the reality will be more complex. The transfer of money to poor households with a higher marginal propensity to consume could lead to pressure on the prices of basic wage goods, especially if there are supply-side rigidities to consider. This is especially true in regions where local markets are not well-integrated with national markets. There is an argument that NYAY could be partly self-funded since it will lead to a consumption boom, but it is important to remember that most basic wage goods are either not taxed or lightly taxed under the GST (goods and services tax) system. The risk may not be an immediate one given the structural surpluses in food right now. Higher inflation in the medium term could also mean that the real income benefits of NYAY will be whittled down. 

Q: Targeting the bottom 20% seems to be a herculean task.Which data can the governments use to identify the bottom 20%? What sort of targeting mechanism would you suggest? 

Targeting will indeed be a herculean task given the informal nature of most economic activity in India as well as the lack of State capacity. The additional problem is that the identification challenge is a dynamic one. The incomes of the poor are very volatile, and millions move across the poverty line because of monsoon or health shocks. So it is not a question of identifying the poorest 50 million households at one point of time, but every year. It may not necessarily be the same 50 million households in the bottom two deciles through time. The delivery problem will be less of a challenge now because of the JAM (Jan Dhan Yojana, Aadhaar and Mobile number) trinity. As Arvind Subramanian has suggested, it would make far more sense to offer income support to all households, and then exclude based on asset ownership. The income support per household will necessarily have to come down sharply if coverage is to be increased. The self-targeting design in the MNREGA scheme cannot be replicated in this case.

Q: The proposed scheme is bound to generate perverse incentives for a significant part of the population.They would try to show that they are a lot poorer than they are or even to lower their incomes in order to qualify. How would you construct the scheme to minimise the damage from this obvious problem? 

The more serious incentive issue will be whether unconditional cash transfers will lead to people withdrawing from the labour force. I do not mean this in the negative sense that the poor are lazy – there is ample evidence that this is not the case. Mainstream economics tells us that the labour supply curve bends backwards as people value leisure at higher income levels. There is also the more practical evidence that women have withdrawn – or more likely forced to leave – the labour force in recent years as household incomes have improved. On the other hand, Abhijit Banerjee and his co-authors have shown in a recent paper (Banerjee et al. 2017) that there is no significant impact of cash transfers on labour supply, but the 70 country case studies they have considered involve relatively low cash transfers in absolute terms and as a percentage of per capita income. NYAY promises an annual income transfer of around 40% of national per capita income, an intervention large enough to change incentives. The positive impact on labour markets could be that reduced income uncertainty will allow poor households to invest in human capital as well as in new activities, as the need to hold precautionary savings comes down. The general equilibrium effects will thus be complicated.

Q: Do you think that the money would be better utilised if instead it is used to improve the existing public education and health services? Or, have we simply given up on trying to make public education and health delivery functional? 

Rathin Roy has argued that India could be moving from a development State to a compensatory State. The State has a role to play in the provision of public goods even in a market economy, and basic income support should not crowd-out funding for public goods. There is also some evidence from field studies that poor households prefer health and education services to cash transfers, though it is possible that these citizen preferences are endogenous in the sense that the failure of previous targeted welfare programmes have led to scepticism about all variants of them. 

This post is part of I4I’s e-symposium on NYAY: https://www.ideasforindia.in/topics/poverty-inequality/decoding-congress-nyay.html  

Further Reading

  • Banerjee, Abhijit, Rema Hanna, Gabriel Kreindler, Ben A Olken (2017).”Debunking the Stereotype of the Lazy Welfare Recepient: Evidence from Cash Transfers Worldwide”, The World Bank Research Observer, 32(2): 155-184.
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