Nudging India’s economic policy for inclusive growth

I had just posted on how the expectations from Economic Survey 2009-10 were not met this year. However, there is one chapter in the survey which is a must read.  It is titled as – Micro-Foundations of Inclusive Growth.The general idea is that to promote inclusive growth we need a bigger role for government. In behavioral economics parlance, more government becomes the default option. However, the chapter says the default option should be opposite – less government.

For achieving inclusive growth there is critical need to rethink the role of the state. The early debate among economists about the size of the Government can be misleading. The need of the hour is to have an enabling Government. India is too large and complex a nation for the state to be able to deliver all that is needed. Asking the Government to produce all the essential goods, create all the necessary jobs, and keep a curb on the prices of all goods is to, at best, court failure, and, in greater likelihood, lead to a large, cumbersome bureaucracy and widespread corruption. 

In many poor nations the Government takes the stance that, when in doubt about the goodness or badness of two or more adults voluntarily conducting an exchange, stop them. An enabling state, on the contrary, takes the view that, when in doubt, do not interfere. There are, of course, many actions of individuals and groups that will need to be stopped for the welfare of society at large. But the default option of an enabling state is to allow rather than stop, to permit instead of prevent. This altered conception of the state can have dramatic effect on the functioning of an economy, in general by promoting greater efficiency and higher productivity. 

(Emphasis is mine).  

Wow! How often do you get to read this from the government sources. Nudging yes but in a different way. 

The paper then looks at how various poverty schemes can be reformed. It revisits the old idea that we should not give individual subsidies like oil, fertiliser etc. But give people the money via coupons and let them decide where to spend the items. The coupons would be given to the PDS shop owner who would cash it with the bank. The bank would take the coupons and cash it from the government. As identifying poor would be difficult, UID system would be useful. 

What if the farmers/poor decide to use the coupons for some other purposes? Say they sell them for some money and buy something else from the money? Should the govt intervene? 

Moreover, it may be desirable to not impose any restrictions on farmers selling off the coupons. If the recipient of a coupon decides that she does not want to buy fertilizers but would rather spend the money on buying a television set instead, we have every right to have misgivings about this preference, but it is not a good idea to use the state’s enforcement machinery to correct this. Modern behavioural economics reminds us that there are situations where individuals act against their own interests because of lack of self-control or inconsistencies in their inter-temporal preferences, and so some paternalistic interventions can be good for them. While this is true, Government action to redirect individual choice ought to be measured and minimal. To try to meddle excessively in individuals’ preferences is a mistake because it encourages Government to reach out to doing more than it realistically can, creating unnecessary bureaucratic hurdles and breeding corruption. 

I don’t think this is a good idea. If possible, we must try and nudge the people into making appropriate buying decisions. And it may not require much intervention either. It may not be possible immediately, but with Unique Identity System, the coupons could have the person’s identity. The coupons can then only be used by the person and only for the desired goods/services. Again he is free to use coupons for food or fertilisers or other such things. But that is where the choices should end. Let us use the nudge approach completely. 

The paper then looks at bureaucratic costs and delays and points to another interesting point. Unlike what we usually think, bureaucracy is not over-staffed and in some departments more people are needed. What is instead needed is an increase in efficiency. It also looks at other perennial India issues – labour laws and rise in food prices. For the current rise in food prices, it advocates a new term – skewflation as it is pretty lopsided. And as all reports say, we need a proper agriculture strategy. 

While saying all this on development, we often ignore the role of social norms and culture in development. 

Hard-nosed Government documents usually make no mention of the role of social norms and culture in promoting development and economic efficiency. However, there is now a growing body of literature that demonstrates how certain social norms and cultural practices are vital ingredients for economic efficiency and growth. Groups and societies that are known to be honest and trustworthy tend to do better than societies that do not have this reputation. There have been broad cross-country studies and also laboratory experiments with the “trust game” that illustrate this. More generally, what is being argued is that a nation’s success depends of course on its resources, human capital and economic policies, for instance fiscal and monetary policies, but also on the cultural and social norms that permeate society.  

We go through life striking hundreds and thousands of minor contracts and deals. You give a person money one day and the understanding is that that person will repair your plumbing the next day or it can be the other way around (the person repairs your plumbing today and expects you to pay him the following day). It is difficult to have such minor contracts enforced by a third party or some formal legal/bureaucratic machinery. If we try to do it that way, as we have on occasion in India, the result will be a cumbersome bureaucracy that is anyway unable to deliver. 

It then adds how behavioral economics is helping us understand these issues better: 

One reason why these “social” causes of development do not get enough recognition in the literature on economic policy is that the science of how these economics-friendly social qualities are acquired is not yet fully understood. Fortunately, the new discipline of behavioural economics is beginning to give us some insights into the formation of customs and behaviour. It is, for instance, known that buildings and office spaces which are cleaner and aesthetically better maintained result in individuals being more honest and desisting from corrupt activity. It is almost as if we have a mental inclination not to defile a good ambience through acts of corruption.  

New York city’s notorious high crime was controlled, among other things, by cleaning up the city and removing graffiti from the walls. New York’s police department took a decision to deter vandalism and graffiti that scar public spaces. This act of making the cityscape more aesthetic somehow made potential criminals less prone to crime.  

One sees casual evidence of this in the behaviour of Delhites using the metro. It has been widely noted that people behave better when they travel on Delhi’s well-maintained metro (postponing their bad behaviour to when they come up to the surface again, some would add). All this is in keeping with the influential “broken windows” theory in sociology, which maintains that, if we control lowlevel, anti-social behaviour and take small steps to improve the environment, this will have a natural deterrent effect on larger criminal behaviour and acts of corruption. 

So, in development we cannot ignore the role of  these “non-economic foundations of economic prosperity“. 

Read the whole thing. Every bit is interesting and refreshing. Though, I am no expert on the role of government. But the way this chapter has been written using interesting ideas from behavioral economics and other examples make it a great reading. 

I have been looking at how Indian policymakers have been trying to use behavioral economics. RBI Dep Governor Shyamala Gopinath suggested using nudges to simplify financial products and our new pension system is based heavily on nudging/behavioral economics. 

This is a much broader application as suggested by Finance Ministry’s Economic Survey. Can we nudge India’s economic policy for better welfare/inclusive growth?  The paper does provide some examples on the same. 

Addendum: 

On reading the abstract, one does not get any clue on what the chapter has to offer. Even the title should have been slightly better. As hardly anyone reads eco survey, it would have been more useful to circulate it as a discussion/concept paper.

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3 Responses to “Nudging India’s economic policy for inclusive growth”

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  2. The Intelligent Forex Investor: World Currency and World Commodities « Forex Critics Says:

    […] Nudging India’s economic policy for inclusive growth « Mostly Economics […]

  3. FinMin’s Economic Survey is fine with teaser loan products « Mostly Economics Says:

    […] Just like we saw in previous survey, this year’s survey has two interesting chapters. First is titled – Micro-Foundations […]

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