Economic Analysis of Direct Cash Transfer scheme

The objectives of the Direct Cash Transfer scheme are noble. The thrust is on transition from the creaky, product-centered subsidies to a system of electronic, direct cash transfers to the needy people. The proponents hail the scheme as a panacea to all current problems. The expectations from this scheme are as follows:

  • There is widespread expectation that moving to Aadhaar and direct cash transfers will generate meaningful fiscal savings
  • The scheme would result in better identification of the poor
  • The scheme simultaneously will be boosting consumption.

The opponents say that the scheme is just a political gimmick that will necessarily result in more inflation.

Is there any potential for Fiscal savings?

Our country’s huge amount of welfare spending is a major contributor to our dwindling public finances. Last year the budget deficit was 5.8% of gross domestic product. The government says the new cash deposit scheme can generate much-needed budget savings by eliminating corruption such as people using fake identification documents to get the same benefit twice.

Here we have to note that if the corruption is eliminated, it would surely result in fiscal savings. Without elimination of the corruption, Cash transfer may not necessarily lead to fiscal savings. Since, the Cash transfers have been linked to the Aaadhar, there seems to be no or minor loopholes in the unique identification. What Aadhaar does is to confirm that “X is truly X”. And this is where the bulk of the fiscal savings lie—by rooting out fake beneficiaries, ghost ration cards and identification-error related leakages.

Will it have a great impact on fiscal health of India?

Bulk of the leakages is attributed to identification errors such as fake beneficiaries, ghost ration cards. These leakages run between 15-20%. The government’s allocation for the schemes potentially eligible to be brought under Aadhaar—PDS food and kerosene, LPG, fertiliser, MGNREGA, scholarships, pensions, Indira Awaas Yojana—in FY13 is likely to be about Rupees 3 lakh crore. If all of these schemes are eventually brought under Aadhaar and the programme is rolled out in the entire country, a conservative leakage savings estimate of 15% would result in aggregate savings of R45,000 lakh crore, which is around 0.5% of GDP. If it does better than expected and plugs leakages to the tune of 25%, this would result in savings of about 0.8% of GDP. Thus we see that the expected outcomes in terms of quantity are much lesser, but still worth. Initially, the benefits will be modest. A very small part (around 3%) of the GDP that is government expenditure on welfare programmes is thought to be brought under Cash Transfers. This means that the scheme may not solve all the fiscal problems in next few years.

Impact of Cash Transfers on Aggregate Demand & Supply:

There are two terms viz. Aggregate Demand and Aggregate Supply. Aggregate demand is the sum of demands for all the goods are services in an economy at any particular time. It is usually defined as the sum of consumers expenditure, investment, government expenditure, and imports less exports. Aggregate supply is the total supply of all the goods and services in any economy.

In the above discussion we have studied that the Aadhaar is expected to generate the savings from de-duplication. When savings are generated, there is a reduction in the government expenditure. When the government expenditure gets reduced, it results in a Fiscal Drag. Fiscal drag refers to a situation when due to lack of state spending or to excess taxation, the aggregate demand reduce in the economy. Thus, on one side, Cash Transfer should dampen aggregate demand and growth. There is another side, which is discussed below:

Possible Impact on Consumption

We take an example here. If 20 kg of rice at Rs. 20 per kg is supplied at Rs. 5 per kg through the public distribution system (PDS), the poor save Rs. 300. In the absence of PDS, he would have spent this Rs. 300 to buy the same quantity of rice from the market. This saved amount now gets spent on other items. Instead, if Rs. 300 is given as cash assistance, the result would also be the same. There would be no decrease in grain consumption but there can be a diversification of poor people’s diet.

On micro economical level, the objective of the Aaadhar linked Cash transfer is that it a greater fraction of the benefit reaches the intended recipients. These are the poor people whose marginal propensity to consume is higher than those middlemen who are currently devouring the benefits. The proportion of the disposable income which individuals desire to spend on consumption is known as propensity to consume. MPC is the proportion of additional income that an individual desires to consume. In case of cash subsidy of Rs. 300 mentioned in the above example, it is probable that the beneficiary uses most part of this subsidy for consumption and that is why he would have higher MPC than the usurper middlemen.

On macro economical level, the direct cash transfers will effectively transfer purchasing power from the middlemen (who presumable are better off and have a relatively lower marginal propensity to consume) to the intended beneficiaries (with a higher propensity to consume). This will increase the “fiscal multiplier” of every rupee the government spends and, all else being equal, boost consumption as well as aggregate demand.

Thus we see that the net impact on aggregate demand will depend on which impact dominates. If the increased fiscal multiplier from cash transfers swamps the impact of lower government spending on account of Aadhaar, the aggregate demand will get a boost. Conversely, if the savings from de-duplications swamp the effect of the fiscal multiplier, demand and activity will suffer a drag.

The government has been accused of using cash transfers as a political gimmick to boost consumption so that it can benefit in the elections.

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