Wednesday, June 22, 2016

Rajan on cash transfers and corruption

Raghu Rajan, who just announced he is stepping down as Governor of the Central Bank of India, gave a very interesting speech, that bears among other things on the question of social programs vs. cash transfers.

A big problem with government provided assistance in India is that the provision is corrupt:
Our [India's] provision of public goods is unfortunately biased against access by the poor. In a number of states, ration shops do not supply what is due, even if one has a ration card – and too many amongst the poor do not have a ration card or a BPL card; Teachers do not show up at schools to teach; The police do not register crimes, or encroachments, especially if committed by the rich and powerful; Public hospitals are not adequately staffed and ostensibly free medicines are not available at the dispensary; …I can go on, but you know the all-too-familiar picture.
Raghu has a thoughtful observation on what keeps this system going:

This is where the crooked but savvy politician fits in. While the poor do not have the money to “purchase” public services that are their right, they have a vote that the politician wants. The politician does a little bit to make life a little more tolerable for his poor constituents – a government job here, an FIR registered there, a land right honoured somewhere else. For this, he gets the gratitude of his voters, and more important, their vote.
...perhaps the system tolerates corruption because the street smart politician is better at making the wheels of the bureaucracy creak, however slowly, in favour of his constituents. And such a system is self-sustaining. An idealist who is unwilling to “work” the system can promise to reform it, but the voters know there is little one person can do. Moreover, who will provide the patronage while the idealist is fighting the system? So why not stay with the fixer you know even if it means the reformist loses his deposit?
So the circle is complete. The poor and the under-privileged need the politician to help them get jobs and public services. The crooked politician needs the businessman to provide the funds that allow him to supply patronage to the poor and fight elections. The corrupt businessman needs the crooked politician to get public resources and contracts cheaply. And the politician needs the votes of the poor and the underprivileged. Every constituency is tied to the other in a cycle of dependence, which ensures that the status quo prevails. 
The Mafia may have had a similar equilibrium

What to do? Cash transfers are an attractive option
... money liberates. Could we not give poor households cash instead of promising them public services? A poor household with cash can patronize whomsoever it wants, and not just the monopolistic government provider. Because the poor can pay for their medicines or their food, they will command respect from the private provider. Not only will a corrupt fair price shop owner not be able to divert the grain he gets since he has to sell at market price, but because he has to compete with the shop across the street, he cannot afford to be surly or lazy. The government can add to the effects of empowering the poor by instilling a genuine cost to being uncompetitive – by shutting down parts of the public delivery systems that do not generate enough custom.
Much of what we need to do is already possible. The government intends to announce a scheme for full financial inclusion on Independence Day. It includes identifying the poor, creating unique biometric identifiers for them, opening linked bank accounts, and making government transfers into those accounts. When fully rolled out, I believe it will give the poor the choice and respect as well as the services they had to beg for in the past. It can break a link between poor public service, patronage, and corruption that is growing more worrisome over time.
...if there is evidence that cash transfers are being misspent – and we should let data rather than pre-conceived notions drive policy -- some portion could be given in the form of electronic coupons that can be spent by the specified recipient only on food, education or healthcare.
 A good summary
 One of the greatest dangers to the growth of developing countries is the middle income trap, where crony capitalism creates oligarchies that slow down growth. [Just developing countries?!] ... To avoid this trap, and to strengthen the independent democracy our leaders won for us sixty seven years ago, we have to improve public services, especially those targeted at the poor. A key mechanism to improve these services is through financial inclusion, which is going to be an important part of the government and the RBI’s plans in the coming years.
Raghu's efforts to reform India's banking and financial system deserve more notice.

(PS: Blogging will be a little spotty for the next week and a half, as I'm off at a glider competition.)


  1. Not just the Mafia. From my reading of American history, Tammany Hall operated in the same way.

  2. Best thing that Modi govt has done is by using aadhar from a mere social security number to launching Jan Dhan Yojana - opening 18crore+ accounts , especially for poor which gets linked to Aadhar.
    The LPG subsidy and other subsidies are now credited directly in accounts. Politicians/bureaucrats/middlemen/frauds go away. People become part of the financial system, corruption reduced.
    Sharing some links

  3. Beyond Tammany Hall, this is indicative of machine politics anyplace. It's also true of the US Congress. Members of Congress have staff who help constituents who are having problems with Federal bureaucracy, using this assistance as a reason for reelection rather than as a failure of the system.

  4. At least as measured, India's GDP is growing nicely.

    Observers say their ruling class, government and infrastructure are terrible.

    Rajan's RBI targeted 4% inflation with a 2% band.

    So is India's growth the result of hard workers and good central bank policy?

  5. Rajan is not stepping down - he is letting his appointment run out without renewal. It appears that he has been forced out.

    The fundamental problem in India is cultural - they have simply made a collective choice to be dishonest and poor.

    My friends from India (who own revenue property in India) say that people are reluctant to use the banks because if you make a large cash withdrawal bank staff will notify associates on the outside and you will be robbed as you leave the bank.

    1. I find the culture argument strange. If they made the decision to be dishonest and poor, how in the world did they manage to grow so fast? I get that a lot(maybe all) is catch up growth but there are lots of countries with flawed institutions that never managed even catch up growth.

    2. They grew so fast by coming off such a low base and picking low hanging fruit made available by the West. China is still twice the Indian GDP per capita.

    3. Part of the reason that India and China have been able to grow so fast is by selling products to the West: if you are producing a product to a Western design, stuffing it in a container and loading it on a boat you are not going to step on the toes of entrenched local interests; you do not have to pay bribes at multiple stages of domestic production and distribution; and you do not have to worry so much about the honesty of your domestic counter-parties.

  6. As an Italian I can say this mechanism is not limited to developing countries, and I find the proposed solution very attractive in its simplicity. However, I would also say that the most favorable situation for clientelism is the one where public services exist but are underdeveloped, in the sense that they cannot service all the people they are targeted towards. The crooked politician can then position himself as a gatekeeper with the power to decide who gets in the system and who doesn't. The differences between italian regions (or between european countries) are a pretty good example for this.

  7. Thanks for sharing this interesting speech by Raghu Rajan, given, I see, almost two years ago. I wonder if while in office he tried to implement any of the ideas he presents here, and how it worked out.

    Good luck aloft!

    John M. NYC

  8. India strikes me as heading towards the italian tranectory. Catch up growth can persist despite deeply flawed institutions, but once you are near the frontier, the day of reckoning comes.


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