In the first part of this two-part series on cash transfers, we tried to address the fundamentals on cash transfers: why it?s important not to confuse unique identification with cash transfers, what the quantum of the end-state savings may be and whether they would solve our near-term fiscal challenges.
In this follow-up piece, we focus on the impact on aggregate demand from introducing Aadhaar and cash transfers. Can they together produce seemingly inconsistent outcomes?reducing the fiscal deficit without hurting aggregate consumption? In turn, can India?s consumer companies hope to reap a windfall from cash transfers? And what does the experience of other countries tell us about the design and efficacy of cash transfers.
What will be the impact on aggregate demand?
On the one hand, there is widespread expectation that moving to Aadhaar and direct cash transfers will generate meaningful fiscal savings. Simultaneously, the government is accused of using this as a gimmick to boost consumption in the run-up to the elections. Folks in this camp fear that this will pressure inflation further. Can both of these seemingly-inconsistent outcomes occur simultaneously?
As alluded to in the first piece, Aadhaar and cash transfers have opposing impacts on aggregate demand. By generating savings from de-duplication, Aadhaar is expected to reduce government expenditure. By itself, this will be a drag on activity. Therefore, as Aadhaar is rolled out across the country and across different welfare schemes, it should dampen aggregate demand and growth. Not to say this is a bad thing. India is in dire need of fiscal reform, and rationalising untargeted subsidies is a good thing. But let?s be clear?by itself this will dampen aggregate demand and consumption as it is rolled out.
And this is where simultaneously introducing cash transfers will be potentially important from a demand perspective. Recall, at its most fundamental level, the value of direct cash transfers is to ensure that a greater fraction of the benefit reaches the intended recipients?the poorest of the poor?who typically have the highest marginal propensity to consume vis-a-vis the middlemen currently usurping a fraction of these benefits. In other words, 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 and aggregate demand.
The net impact on aggregate demand will depend on which impact dominates. Will the increased fiscal multiplier from cash transfers swamp the impact of lower government spending on account of Aadhaar? If so, 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.
For any given level of fiscal savings, the higher the difference in marginal propensities to consume, and the greater the plugging of leakages (i.e. greater fraction reaching the intended beneficiary), the greater the chance that demand and consumption get a boost.
Will consumer companies experience a bonanza?
Are India?s consumer non-durable companies on the cusp of reaping a bonanza? This will depend on two key factors: (1) the net impact on aggregate demand (as discussed above); but, more importantly, (2) whether cash transfers are conditional or not. When the large subsidies (food, fuel, fertiliser) are brought under the ambit of direct cash transfers, will the government force recipients to buy food, fuel and fertilisers at market prices and then compensate them, ex ante or ex post? Or will this eventually migrate to an unconditional cash transfer?households will receive and be permitted to spend an equivalent amount of cash however they deem fit?
From an allocative efficiency standpoint?the latter is clearly optimal. Each household can decide what its priorities are rather than being forced to consume predetermined quantums of food and fuel at subsidised prices. A concern is that the cash will be ?misused? by certain members of the family. However, the experience of other countries has shown that the consumption of sin goods does not necessarily increase on account of cash transfers, and that when transferred to the oldest female head of the household, these concerns are further alleviated.
From the standpoint of consumer companies, only unconditional cash transfers will spur demand for consumer companies (except for programmes that are already paid out in cash?welfare and scholarships?where leakages will be plugged, but this is a small chunk of the pie). If cash transfers are contingent on buying pre-designated goods at market prices from PDS shops, the impact on outside consumption is expected to be small.
But hasn?t all this been done in other countries?
Skepticism about the efficacy of cash transfers is often countered by noting that cash transfers have been successfully executed in other emerging markets. Mentions of Brazil?s Bolsa Familia and Mexico?s Opportunidades are now an integral part of the discussion of cash transfers in India.
Before we get to the learnings of these programmes, it is important to first acknowledge the differences in scale and architecture. For starters, the federal Bolsa Familia programme serves 46 million people and Opportunidades serves 20 million people. We aim to roll it out hundreds of millions! Yet, that is a technical issue and presumably will eventually be overcome.
But there are crucial architectural differences as well. By moving to cash transfers, India is aiming to reduce the role and machinery of the state. In contrast, conditional cash transfers in Latin America seek to do exactly the opposite?use cash transfers to incentivise greater usage of publicly-provided services in health and education!
So what learnings can we glean from other countries? First, that unconditional cash transfers do not necessarily result in the increased consumption of ?undesirable goods? (alcohol, tobacco, etc). Studies have found that cash transfers have almost always resulted in greater food acquisition and often of protein-rich foods in particular (which would put more pressure on protein inflation in India!). Some studies find increased household acquisition of clothes and footwear. One consistent finding is increased allocation of expenditure towards children. These findings are more likely if the transfer is made to women in the household.
The implication is clear: families know best how to allocate household budgets. And each family will inevitably have a different set of priorities. Unconditional cash transfers can therefore deliver greater allocative efficiency.
But, remember cash transfers around the world are typically contingent on health and education attainments (for example, young children and pregnant women have to typically go for a regular health check-up and older children/ girls to school to avail the transfer). So did they achieve the desired outcome? Cash transfers have been successful in overcoming demand-side barriers and improving school enrollments, particularly amongst girls. But actual education and health outcomes have sometimes been less satisfactory, largely due to supply-side constraints and problems with service delivery.
That said, there were powerful demonstration effects, wherein families that did not qualify for cash-transfers were also induced into attaining greater education and health services, in response to what they were witnessing in their community.
The true game-changer
All told, Aadhaar has the potential to eventually generate significant financial savings. And the government must be commended for trying to eliminate leakages. But, more fundamentally, we need to move away from untargeted subsidies like those on diesel?that destroy allocative efficiency?and combining savings with those of Aadhaar to make critical investments in health and education. Then, cash transfers need to be used to incentivise greater health and education outcomes as in Latin America. That will be a true game changer for growth and social progress in India.
This concludes the two-part series. The author is India economist, JP Morgan