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October 3, 2017

The fiscal myth

  • However, the argument that government spending can revive the economy and put it on a high-growth path is based on weak economic logic. Support for aggressive fiscal stimulus measures usually comes from the belief that it can put more money in the hands of citizens, thus spurring them to spend and boost demand in the economy. This is the famous Keynesian “multiplier effect” that economists talk about as a tool to counter economic downturns. Apart from the fact that citizens do not necessarily have to spend the money they receive from the government, the logic of fiscal spending is found wanting on various other levels.

Disruption in production

  • For one, contrary to Keynesian orthodoxy, insufficient demand is often not the primary reason behind an economic slowdown. Instead, it is only the side effect of production shocks, like the chaos induced by the implementation of the goods and services tax (GST), that cause the income levels of people to drop and, in turn, affects their ability to spend. Fiscal stimulus does nothing to address the root of the problem, which is disruption in production rather than insufficient demand.
  • Two, fiscal spending is a zero-sum game, wherein resources are misallocated from their original use towards other ends. Taxes that the government collects to spend on the economy, for instance, come out of the pockets of citizens who would otherwise spend it according to their own tastes. Such taxes also weigh negatively on an economy that is already reeling under the impact of other disruptions to production. On the other hand, when the government borrows from the credit markets to fund its spending habits, it distorts the spending and saving decisions of citizens. Even when additional fiscal spending is funded out of thin air, for instance through deficit spending funded by the central bank, the misallocation of resources is unavoidable.
  • Three, while fiscal spending is praised for its ability to employ idle resources, it should be remembered that it also impedes the movement of such resources towards more productive employment. In fact, fiscal spending can artificially prolong a recovery by delaying economic adjustment.
  • In order to foster genuine recovery, the government must undertake pro-market reforms that can help the economy quickly recover from the shocks of demonetisation and GST. Anything less will only expose the Centre’s inability to carry out tough economic reforms.

The cost of electricity

  • The cost of electricity can be divided into plant-level costs, grid-level costs, and other costs. Plant-level costs consist of capital, operation and maintenance, and fuelling cost. Capital cost is reflected in the cost of generation by way of interest on debt and return on equity. For nuclear power plants, capital cost is high, but fuelling cost is low. For coal-fired power plants, capital cost is low, but fuelling cost is high. The capital cost of solar and wind is continuously decreasing; fuelling cost is nil.
  • Electricity reaches a consumer through the grid. Laying a grid needs significant investment. A distributor buys electricity from a generator, adds transmission and distribution charges, a charge to recover technical losses, operating expenses, and his profit to determine the tariff to be charged from a consumer. Since several generators are connected to the grid, interaction with the grid and grid-management policies influence the working of a generator. At present, electricity markets do not assign any price to system effects, that is, to the complex interactions among various generators connected to the grid.
  • In recent years, a large capacity based on variable renewable energy (VRE) sources has been connected to the grid. These sources are intermittent, but get priority feed-in due to nil fuelling cost. A grid manager must ensure that enough dispatchable generation capacity is connected to the grid to meet the peak load in the evening when solar power is not available. Dispatchable generation is provided by baseload technologies like coal and nuclear, and by large hydropower.
  • Grid-level costs have several components: grid connection, grid extension and reinforcement, short-term balancing costs, and long-term costs for maintaining adequate back-up supply. VRE sources demand much higher back-up, grid connection and reinforcement costs. This aspect needs attention during policy formulation.
  • In December 2016, the Central Electricity Authority issued a draft national electricity plan (DNEP), which refers to system effect and resulting system cost at several places.
  • The emphasis on VRE sources without any investment in energy storage has converted daily load profile for dispatchable generating stations into a “duck curve”, that is, with a reduced electricity load during the day when solar is available and a rapid ramp up in the evening. This lowers the capacity factor of dispatchable generators. The DNEP acknowledges technological and operational challenges posed by the integration of VRE into the grid. It highlights the loss of generation efficiency, high maintenance cost, and higher emissions of combined cycle plants due to cycling and ramping. It details grid integration cost of VRE in qualitative terms.
  • A recent report by the Department of Energy, U.S., highlights another element that is smoothening of transients in the grid by the inertia of the rotating mass present in thermal power plants, while solar plants have no such feature.
  • System costs have been quantified by the Nuclear Energy Agency of the OECD and differ across countries depending on the extent of presence of sources like natural gas. According to this quantification, system cost of VRE sources is much higher than nuclear and coal. True parity of VRE sources will be achieved only when the sum of generation cost and system cost matches with that from dispatchable sources.

Other costs

  • Other costs include those arising from the influence of electricity generation on health, influence on existing generation capacity due to adding new capacity, cost of accidents, security of supplies and net energy gain for society.
  • In the Economic Survey 2016-17 (Volume 2), an attempt has been made to estimate grid-level costs and some other costs. The survey uses the term ‘social cost of carbon’ to represent economic cost of greenhouse gas emissions. It also adds health costs, costs of intermittency, opportunity cost of land, cost of government incentives and cost arising from stranded assets. It, thus, includes not only system cost, but a significant part of other costs as well. It estimates that the total social cost of renewables was Rs. 11 per kWh, around three times that of coal.
  • Conventional metrics like levellised cost of electricity generation cannot be relied on to compare intermittent and dispatchable electric supply options. India’s electricity requirements are enormous. It doesn’t need a ‘technology versus technology’ debate, but a policy framework that integrates all low-carbon energy technologies with coal in a manner that ensures reliability and security of electric supply along with affordability and climate-resilient development.

Urban upgrade to smart governance

  • The “resilient Mumbai spirit” in the face of crisis has been lauded by many. But when crises keep occurring frequently, it is a sign that something has gone badly wrong with the city’s governance. The rush-hour stampede at the city’s Elphinstone Road railway station on Friday, in which 23 people died and many were injured, follows just after heavy rain and flooding last month that brought the city to a halt and also cost lives. How did we get here and what should be done?

Outpaced by growth

  • The area around the railway station has undergone a dramatic transformation over the years. As the textile and manufacturing industry declined and eventually died out within the city, this area saw the rise of services and commercial activity. This development, which involved the construction of high-rises for offices and residences, occurred without any adaptive response from the public authorities to address transportation challenges and ease the pressure on the existing transport infrastructure. The footfalls in surrounding railway stations, of those commuting to work in these areas, increased manifold exposing the woefully inadequate carrying capacity of bridges and stairways here. This is the same story in other parts of the city as they undergo a transformation in land use in response to changing economic activity. Therefore, one may ask why the authorities have not been more responsive to the dynamic city.

Lack of coordination

  • A key reason is the absence of coordination among the many public organisations undertaking various civic and infrastructure-related functions in the city and metropolitan region. Besides the Municipal Corporation of Greater Mumbai, which is the urban local body providing basic amenities and discharging functions such as solid waste management and sanitation, there is the Mumbai Metropolitan Region Development Authority which creates regional plans and plans for special planning areas; the Mumbai State Road Development Corporation that undertakes road projects; the Ministry of Railways whose parastatal organisations look after the suburban railway network; and the Mumbai Port Trust, currently planning the commercial development of a part of its land, among others. There is no joint formulation of transport plans in tandem with land use plans by these bodies. Ultimately, the obfuscation due to overlapping functions and jurisdictions undermines accountability.
  • The second is a lack of an adaptive and flexible planning process in response to the economic forces that drive demand for land and land use. Planning authorities typically prepare land use plans for a 20-year horizon and in the interim, any upgrading of transport infrastructure and new projects is undertaken in an ad hoc fashion by the respective organisations.

Case for an entity

  • Coordination and cooperation among all public authorities concerned needs to take place not just in response to a crisis but as a regular and routine feature of the governance set-up. This requires a single coordinating agency. There are already certain provisions and studies that could aid the setting up of such an entity. The 74th Constitutional Amendment Act calls for establishing metropolitan planning committees (MPCs) for metropolitan regions. However, the experience of MPCs has been disappointing because of lack of autonomy, executive power, finances and functionaries.
  • Studies on metropolitan governance in India have recommended creating metropolitan councils entrusted with specific powers that are appointed democratically. Then there are other successful instances of transport planning and other functions being managed at the metropolitan level for regions such as London and New York that could be useful case studies. In reforming the governance system, the existing political incentives of public officials will have to be considered and necessary checks and accountability mechanisms put in place.
  • It is crucial that the agency have a clear functional mandate and adequate autonomous power for planning and decision making. Further, it should have jurisdiction over certain functions such as transport for the entire metropolitan region. Besides transit, other functions such as solid waste disposal and water supply, that require provisioning at a regional level, could be delineated to be undertaken by this agency. It needs to have representatives from other public organisations and domain experts from outside the public sphere. Finally, it needs to be accountable to citizens for the functions in the region. This could be done by having direct or indirect elections to appoint the political head for this agency.

Tackling the economic slowdown

  • Economic growth has slowed for five consecutive quarters, that is from late 2015-16 onwards. By now growth is slower than it was in the quarter in which it assumed office. For a government that had promised to turn around the economy through decisive governance, this must serve as a wake-up call.

Why growth matters

  • Growth matters in India as a large number of persons have to make do with far too few goods and services as it is, which is how poverty is defined. Note that these goods also include public goods or goods that are accessed by the entire populace of a country, such as parks, roads and bridges. Since these public goods are provided by government, the government needs tax revenues to supply them, and these depend upon national income. Then there is employment. A demand for labour exists only when there is a demand for goods. So growth is necessary if employment is to be assured.
  • In India we not only have a pool of unemployed persons to absorb but we also need to provide employment to youth continuously entering the labour force. From this point of view, the slowing of the economy is a source of concern.
  • The first thing that comes to mind when ‘more structural reforms’ is proposed is that reforming is what all governments have been claiming to do for more or less a quarter of a century now. Since 2014, in particular, “the ease of doing business” has received great attention from this government. The economy today is far less regulated than it was in 1991. It would be correct to say that labour market reforms have not been taken up yet in Parliament and that exit is necessary for a dynamic economy. Labour laws in India make exit difficult, and complying with requirements with respect to the hiring of labour is time consuming and therefore costly. It is possible that the share of manufacturing will rise if the labour market is liberalised. And, though only a one-time gain, this could even benefit labour. However, it is not clear how this relates to the situation today which is one of slowing growth.

Landing an excuse

  • It is when it comes to the land market that the argument for more reforms is least obvious. Apart from restrictions on conversion of agricultural land, no policy stands in the way of private parties transacting with one another. Surely, we can’t treat the issue of the alienation of agricultural land so casually as to remove all discretion vesting with government. If the argument is that the government must ensure as much land to private industry as they seek, though at a price, this is an intervention out of sync with a market economy. In this context, it may be said that an intervention that government in India should avoid is facilitating land acquired for industry to be alienated from manufacturing activity. Cases in question range from land owned by public sector units in Bengaluru, private mills in Mumbai and private industry in rural Kerala.
  • For credibility, the argument made for land and labour market reforms as a pre-requisite for accelerating growth today must be able to account for how the economy came close to achieving 10% growth in the late 1980s and during 2003-08 when the policy regime was no more liberal than it is now. Equally, it would be difficult to relate slowing domestic growth to sluggish world trade as data show 2016-17 to be a year of a major turnaround in exports. On the other hand, capital formation as a share of output has declined almost steadily for six years now. In 2014-15 it rose slightly, as if in cue to Mr. Modi’s arrival, but soon resumed its sliding at a faster rate. The government appears to make light of this development. Actually, it contributed to the downward trend by reversing the rate of growth of expansion of public capital formation from 2015-16.
  • It is generally the case that it is capital formation, or investment, that drives growth in the economy. Investment is an immediate source of demand as firms that invest buy goods and services to do so, but it also expands the economy’s capacity to produce. Of the two sources of investment, namely private and public, the first has been depressed for some years. In a slowing economy, private investment is unlikely to revive in the absence of some external force. This is so as investment involves committing funds for a long period under uncertainty. It is for this reason that economic theory prescribes the stepping-up of public investment when private firms are unwilling to invest more. Not only does increased public investment increase demand and quicken growth but it may be expected to encourage private investors, as the market for their goods expands.
  • Other things being the same, increased public investment leads to a higher deficit, which is the gap between the government’s expenditure and its receipts. Among economists themselves there is resistance to governments running a deficit for fear that it may be inflationary. But in any such assessment, the increase in inflation must be offset with the increase in growth that would have been achieved due to greater public investment. In India, the increase in inflation that could come with higher growth would be due to the shortage of agricultural goods. So any plan for increasing the rate of growth, not just at the present moment but in general, must reckon with agricultural shortages. We have not yet fully solved this problem in India, whichever the party at the Centre.

Don’t be afraid of deficits

  • Since 2014 the government has focussed aggressively on the supply side by making it easier for private firms to produce. But we are now facing a demand shortage in the economy. The immediate thing to do is to expand public investment in infrastructure. The argument found in the media that there are “no shovel ready projects” is to encourage lazy governance. Repair and reconstruction of India’s creaking infrastructure is the direction in which greater public investment must now flow. It is the most direct and potent measure that can be undertaken to address the slowdown the economy is experiencing.