Context: The provisional estimates of Gross Domestic Product (GDP) highlights that the Indian economy is going through a rough patch. The underlying growth rate is lower than what was expected and estimated by the government.
This slowdown is despite the rising capital expenditure in various budgets. An increase in revenue expenditure, particularly in the social sector, can help reverse the current growth decline happening in India.
Relevance of the Topic: Mains: Analysis of fiscal expenditure.
How does the nature of Fiscal Expenditure impact Growth?
1. Impact of Revenue Expenditure:
- Those at the lower end of the income spectrum have a higher propensity to consume as compared to the richest.
- If state spending tilts in favour of the working class, the income and employment multiplier effects of such spending would be much larger.
- For example, consider the government is spending ₹100 as NREGA wages or pension to the elderly.
- The entire ₹100 can be used to increase workers’ consumption demand.
- This increase in demand, say on food and clothes, generates income for those employed in producing these commodities. This creates a multiplier effect in the economy.
- Also, the import component is negligible. The whole amount will be used up domestically.
2. Impact of Capital Expenditure:
- For example, consider the government is spending ₹100 in commissioning a large scale dam/nuclear project.
- Here, only a part of ₹100 can be spent as wages. This reduces the rate of increase in consumption demand from workers’ class, thus reducing the multiplier effect.
- Also, there is a likelihood of a greater leakage of demand to the rest of the world in the form of higher imports (like heavy machinery required for a dam or a nuclear reactor).
- So, the domestic component of this multiplier might be even lower.
3. Income Transfers:
- Direct income transfers (whether in cash or kind) to the workers at the lower income group, stimulate demand for mass consumption of goods.
- A mere change in the composition of government expenditure in favour of such transfers, creates extra demand.
4. Welfare-based legislations:
- During 2004-2011, the government introduced a major welfare scheme- NREGA and fixed its wages higher than the prevailing market wages.
- This generated additional jobs as well as set a floor for rural wages. This rise in rural wages pushed up wages for casual unskilled workers.
5. Social services & Development expenditures:
- There was a sharp rise in the share of social services expenditure as well as development expenditures out of the total expenditure of the Union government during 2004-2011.
- Developmental expenditure: expenditure on economic as well as social services. Includes the spending on agriculture and rural development.
- Social sector expenditure: only includes the direct social sector spending such as education, health and welfare programmes.
- This change in the nature of fiscal spending had a significant impact on consumption, across different categories of commodities, for the bottom 80% of the population.
Reasons for the Present decline in growth:
- Exclusive focus on Capital expenditure: While the government has acknowledged the slowdown and the lack of private investment, its response has been to focus on capital expenditure. This was done even as the share of fiscal expenditure (as a % of GDP) was falling.
- Unmet expectations in private investment: The exclusive focus on capex was done with the expectation that this would crowd-in private investment. But, the corporate sector has not responded either to this or to the tax cuts from 30% to 22% in 2019.
- Stagnant Private Consumption: Under conditions of slowdown or lack of demand, investment responds more to the level of activity than to cost considerations. If the existing factories are not running to capacity, the firms would not invest more even if they are flush with funds (in the form of post-tax profits) or have access to cheap credit.
Way Forward
- Rise in the share of revenue expenditure:
- An increase in revenue expenditure, particularly in the social sector, would result in a virtuous cycle of higher income for the workers.
- This will further lead to higher income and employment multipliers, which may kick-start private investment as well.
- Shift in the nature of capital expenditure: Capital expenditure must be focused on labour intensive projects that have a higher multiplier. E.g., Affordable housing projects, rural infrastructure projects.
- Implementation of direct income transfer schemes for low income groups would reduce income inequality and boost consumption expenditure.