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24 January 2017 Question Bank


24th JANUARY 2017


(1 Question)

Answer questions in NOT MORE than 200 words each. Content of the answer is more important than its length.

Links are provided for reference. You can also use the Internet fruitfully to further enhance and strengthen your answers.


1.             “Far from government spending via borrowing crowding out private expenditure, it leads to a ‘crowding in’ whereby the demand generated by government spending expands the market for private investors, raising the level of economic activity today and even in the future. Also rational government spending is more effective policy tool than providing Universal Basic Income (UBI).” Comment.


Concerns over government borrowings:

  • In a recent speech made in Gandhinagar, the Governor of the Reserve Bank of India is reported to have cautioned the government against increasing its borrowing.
  • He is reported as stating that “the government should desist from borrowing even more and pre-empting resources from future generations”.
  • He asserted that “government borrowing tends to crowd out private investment”. There is no unconditional validity to these propositions. This has been known to economists for over three-quarters of a century.

Why government spending pays

  • It is difficult to make sense of the proposition that government spending by means of borrowing pre-empts resources from future generations.
  • Actually, directly or indirectly, every expenditure will serve as a draught on today’s resources, i.e., labour and capital equipment.
  • But why should this ever amount to pre-empting resources from future generations? Unlike natural capital, these resources are man-made, and expenditure can actually create more of them.
  • Furthermore, these newly-minted resources are inherited by future generations who far from being short-changed are left with more income-earning assets than they would have had were the government to desist from borrowing to spend today.
  • Sure, future generations would have to pay more taxes to retire the government’s debt, but so long as the returns are greater than the interest burden, future generations are unambiguously better off.

Resort to Quantitative easing

  • Presumably, it is the possibility of a rise in the interest rate that unleashes the challenge in the form of the argument of crowding out, whereby a rise in public spending raises the interest rate faced by the private sector. But, as the Governor should know, this can be simply and effectively dealt with through monetary policy.
  • Quantitative easing in the United States was precisely such a mechanism whereby the central bank ensured that an expansionary fiscal policy following the financial crisis did not result in a rise in the interest rate.
  • Far from government spending via borrowing crowding out private expenditure, it leads to a crowding in whereby the demand generated by government spending expands the market for private investors, raising the level of economic activity today and even in the future.
  • Of course, this requires the existence of unemployed resources, which is mostly the case in a large part of the economy.
  • So, the assertion that greater public spending would crowd out private investment is based jointly on a refusal to accept accommodating monetary policy as valid and the assumption that the economy is at full employment.

 The universal basic income idea

  • A case has been made for the provision by government of a universal basic income (UBI).
  • This idea has been floating around the capitals of the western world for a while, and it is not surprising that policy entrepreneurship would ensure its appearance here and its feasibility has been demonstrated, so to speak.
  • Thus the economist Vijay Joshi has in his book, India’s Long Road, proposed that every citizen be given an income transfer equivalent to what is needed to raise those currently deemed poor to above the official poverty line.
  • He shows that this would involve a transfer of ?3,500 per capita per annum.

Universal Basic Income idea unfeasible:

  • The virtue of this arrangement, it is claimed, is that it would eliminate poverty and yet leave some over to actually raise public investment.
  • However, it is an unusual approach to poverty eradication that the non-poor, who in India are the majority and some of whom are rich by international standards, be given the same income as the poorest.
  • It may be imagined that the idea of UBI is based on the social democratic imagination, but the welfarism that it implies is neither socialist nor democratic. It is distinctly at odds with Karl Marx’s vision of a decent society as one which draws from “each according to their abilities (and gives) to each according to their needs”.
  • Enthusiasts of the UBI would need to account for a scheme in which the able-bodied receive as much as the infirm and infants receive as much as their mothers.
  • There appears to be a mismatch between rights and responsibilities here.
  • And, above all, in our present state of development and given the current state of the public finances, the UBI would leave India bereft of public goods and services.
  • Once everyone has been given a certain amount of income under the auspices of the state, it gets absolved of all responsibility for providing public goods and services which the private sector has no incentive to provide.

Rational government spending

  • Public borrowing is not necessarily bad but borrowing to distribute for consumption is to be guarded against.
  • Certain subsidies in India are regressive and others do not even entail a transfer, such as when foodgrain rots in the godowns of the Food Corporation of India while getting accounted as food subsidy in the books.
  • The answer to the accumulating subsidy bill lies less in moving to the distribution of its cash equivalent as much as to transferring the potential saving from their elimination into public investment.
  • Not only does public investment have a greater impact on growth than subsidies in their present form but, to return to the issue of inter-generational equity, the capital formation that it entails benefits future generations by enhancing the productive capacity of the economy.




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