Soon after the elections, Suman Bery, the head of the National Council for Applied Economic Research, asked me in what way the Left would be influential.
My answer was that it had enlarged the definition of public goods in India by creating, if you will, a class of quasi-public goods such as electricity, water for irrigation, transport and so on.
This meant that the mere inability to pay for these things could not prevent the non-payers from consuming them, even though the marginal cost of producing them is not zero. The state would pay, just as it would for the traditional public goods, by taxing those whom it could without having to pay a political price for it.
A huge amount of research has gone into the subject abroad but typically not in India because Indian economists are like that only. One of the more perceptive papers is by John C Goodman and Philip K Porter.
In their paper* they predict that when the marginal influence of consumers is greater than that of the taxpayer, "public goods will be overproduced and the public sector will tend to over-respond to changes in demand and under-respond to changes in costs".
What happens is that "variable Budget allocations tend to ameliorate the effects of changes in costs". The economy is then left with three things: a cost-plus system of procurement, entitlements that guarantee benefits regardless of cost, and targeted tax revenues (for example, a cess) that guarantee a revenue source regardless of cost.
Does this mean that every public good will be overproduced, as say happens in the case of defence expenditure? No, say the authors.
All it means is that "if the effort-benefit ratio of consumers is sufficiently small, a public good will not be produced at all. In general, public provision of goods that are under-produced will under-react to changes in demand and overreact to changes in cost, reflecting the superior marginal influence of taxpayers vis-à-vis consumers."
This suggests that while the traditional public goods, such as defence expenditure and civil servants, could be overproduced, the quasi ones such as electricity and so on could be under-produced.
The model also predicts that when the political system is forced to choose between a large number of programmes -- health, education, jobs -- spending will be allocated on the basis of political, rather than economic, costs and benefits.
"On the whole, the model leads us to expect large welfare losses in the production of public goods -- many times greater than what we generally find in the private sector."
The model also predicts that "whenever the political equilibrium is sub-optimal, the potential return from an additional dollar invested in politics will always be greater for the group that has the lower effort-benefit ratio."
Thus, if a public good is being under-produced, an additional dollar invested in political action will produce a larger payoff for consumers than for taxpayers.
This means that consumers will have a greater incentive to increase their investment in political action as opposed to private sector investments. The converse is true whenever goods are being overproduced.
Another finding, which fits the Left in India perfectly, is that under certain conditions, unionised employees in the production of public goods can end up enjoying increasing returns to scale.
This may help explain why the power of public employee unions seems to have grown over time even as the power of unions generally has been on the wane." The Indian producers of the quasi-public goods are an excellent case in point.
The central point of relevance for India that emerges from this paper is that "not only will the public sector tend to produce non-optimal quantities of public goods, it will tend to respond to changes in market conditions in non-optimal ways."
The paper ends by asking a question that Murli Manohar Joshi would have liked to answer: should governments support higher education through direct spending or by giving tax credits to students and their families?
They give some more examples but their thrust is clear: should not citizens be allowed to make private choices through tax credits, especially as these reduce distortions on the spending side? It is too late for P Chidambaram to include such credits in his first Budget, but hopefully he will present the next one also.
*Political Equilibrium and the Provision of Public Goods